Insights

Alexander Wright, Partner & Global Wealth Strategist

After two consecutive years of stellar performance in the  equity market and further tightening of credit spreads, public market valuations are, as of this writing, well above their long-term averages. Additionally, the US economy keeps firing on all cylinders and inflationary pressures remain, pointing to an environment where interest rates will likely remain higher for longer.1 This creates challenges for investors and poses a
key question for allocation adjustments in 2025: What can one do to enhance potential returns, improve diversification, and mitigate volatility? This paper discusses these critical points in detail.

First, let’s examine the challenges by taking a deeper look at the current state of public markets. Take US public stocks, for example: The historical relationship between the S&P 500 forward price/earnings (P/E) ratio and subsequent three-year returns for the benchmark index shows that the current forward P/E ratio of almost 22 implies a 3% inflation-adjusted annualized return over the coming three years (Exhibit 1), well below historical averages of around 6.4%. While the S&P 500 delivered gains in excess of 20% in 2023 and 2024, the current technical backdrop suggests a more tempered outlook for the coming years.

KEY TAKEAWAYS

• Public markets are expensive and concentrated: Both public stocks and bonds are trading at elevated valuations, offering low risk premia. In equities, performance is increasingly reliant on a small group
  of mega-cap stocks, amplifying portfolio risks.
• Diversification is harder to achieve: The rising correlation between public stocks and bonds has practically eroded the diversification benefits of the traditional 60/40 portfolio, leaving investors more exposed to systemic risks.
• Private markets can enhance portfolio resilience: Private markets can offer access to differentiated return drivers, lower correlations with public markets, and opportunities to improve risk-adjusted return potential, which we believe make them a valuable component of a broader portfolio strategy, especially in light of high public market valuations.

Read the full article here.