Dan Brocklebank, UK director at Allan Gray’s offshore partner, Orbis

The dominance of US stocks in global markets has reached extremes not seen since Japan’s historic market bubble in 1990, raising concerns about concentration risk. With 75% of the MSCI World Index now comprising US stocks, many investors may be overexposed to an increasingly expensive market at risk of correction, argues Dan Brocklebank, UK director at Allan Gray’s offshore partner, Orbis.

“History suggests that high levels of concentration tend to precede painful market reversals,” asserts Brocklebank. He believes that just because the majority of the world index is comprised of US stocks, that doesn’t mean that investors should blindly follow the trend and position their portfolios to mirror the index. “Accepted wisdom can turn out to be very wrong over time,” he points out. “We have to be wary of strong market consensus and where it has created big concentrations in markets.”

The parallels to previous bubbles are clear. “Japan once made up more than 40% of the world index before its stock market collapsed in the early 1990s,” Brocklebank says. “A decade later, investors piled into dotcom stocks, assuming their dominance would last – until the tech-heavy Nasdaq crashed nearly 80% from its peak.”

Today, US mega-cap stocks like Amazon, Meta, Alphabet and Microsoft have become the new market darlings, fuelled by faith in the capabilities of artificial intelligence (AI). “Investors behave as if the growth of these shares is inevitable, despite warning signs that their valuations may have run ahead of fundamentals,” he states.

Filter for signal

Rather than merely following the market consensus, Brocklebank contends that investors should rely on real insights. “To be successful as an investor, you have to be willing to do something different and the edge lies in seeing what others are missing,” he says.

A key part of this approach is filtering out the investment “noise” to find the right signals. Brocklebank argues that there are three investment signals that are widely ignored today: the scale of speculative activity, the growth of US shares over the past 15 years, as well as their high valuations.

“The average price-to-earnings (PE) ratio of companies on the S&P 500 is approximately 24,” he notes, adding that AI hyperscalers are spending big just to keep up. “The ratio of capital expenditure to sales for the US tech giants is 20,” he says, which confirms for many that AI spending may not yield the massive returns originally envisioned.

Despite growth in the S&P 500 of 13.8% per annum over the past 15 years, he points out that this superb performance is not normal and is being influenced by the rise of passive fund management.

Brocklebank also notes that many investors have adopted YOLO (You Only Live Once) and FOMO (Fear of Missing Out) mindsets, which appear to be influencing their behaviour and markets.  “There has been an explosion of speculation which has come on top of a general trend towards gamification of markets in recent years.”

Proper diversification is key

While investors have to navigate unpredictable market dynamics, there are still ways for them to mitigate investment risks. “The future is more uncertain than we realise and we need to remain humble,” Brocklebank says. “In terms of investing, it is critical to think about resilience and protecting your portfolio against the full range of potential outcomes.”

Now more than ever, proper diversification is key. “The most diversified portfolio is one that holds a bit of everything: assets from North America, Europe, the UK, Japan, Australasia and emerging markets,” Brocklebank explains. He believes there are more compelling investment from a valuation perspective beyond the US. “The forward PE ratio of US stocks is approximately 22, while the rest of the world’s stock markets offer more modest PE ratios of 14,” he says.

Ultimately, one of the key roles of financial advisers is to help their clients remain grounded and recognise that certainty is a scarce commodity. “With today’s market being so significantly skewed in favour of the US, the need for diversification is more acute than ever,” Brocklebank concludes. “The best thing you can do today is to make sure that you are properly diversified.”