- Passive flows and AI enthusiasm have pushed valuations well above historic norms.
- Relying on valuation alone risks missing extended bull markets; entering without discipline risks losses.
- A process that combines fundamentals with technicals helps investors participate with confidence
Process, not prediction, secures gains when markets turn irrational
The S&P 500 now trades at valuations above the dot-com peak. Nvidia alone is worth more than the GDP of most countries. Much of this buying is not driven by investors weighing fundamentals, but rather by automated flows that buy regardless of valuation.
Markets continue to rise on momentum, driven by passive inflows and enthusiasm for artificial intelligence. Step aside, and you miss years of gains. Step in without discipline and you risk ruin. The answer is not prediction but process – an approach that respects both fundamental valuation and market behaviour.
Valuations no longer anchor markets
In 2024, passive funds overtook active funds in U.S. assets for the first time. Exchange-traded funds drew nearly $1 trillion in inflows, while active mutual funds continued to lose assets. Passive vehicles are bought based on index weights, not intrinsic value. Price matters. Fundamentals do not.
This detachment pushes valuations higher. Investors are swayed by fear of missing out. Herd behaviour amplifies the effect, and passive flows further magnify it.
The pattern is not new. In the late 1800s, when tinned sardines became scarce in Alaska, one miner paid $100 for a tin of sardines that cost $0.10 in New York, only to find that they were rotten. When he complained, the seller shrugged: “Those are trading sardines, not eating sardines.” The parable remains relevant in today’s markets.
Why fundamental valuation alone fails
Between 1995 and 2000, the Nasdaq 100 rose by more than 800%. On almost every measure, the market looked expensive well before the peak. Tony Dye left Phillips & Drew in February 2000 after refusing to buy technology stocks based on valuation. The market turned soon after, and his judgment was confirmed too late.
The same tension is visible today. Nvidia, Microsoft, and Palantir trade at multiples well above history. However, a recent MIT study found that 95% of generative AI pilot projects have failed to deliver results.
This is why fundamental valuation alone fails. Ignore valuation, and you may ride a wave that ends in ruin. Rely solely on valuation, and you may miss years of gains. The answer is to use a process that respects both price and value, a set of guardrails for irrational markets.
Guardrails for irrational markets
The way forward is not to choose between conviction in value and surrender to momentum. It is to use a framework that blends both.
A technical overlay is a guardrail system. It lets you capture most of the upside and signals when momentum breaks. In practice, this means staying invested while trends are strong and stepping aside when price confirms the run is over.
Momentum is one of the most persistent features of markets. Research shows that strategies respecting price trends deliver strong returns in extended bull runs and preserve capital in downturns. For investors and allocators, this is not theory but survival.
Conclusion: discipline, not hope
Markets can remain irrational longer than anyone expects, and experienced investors know these cycles are not unusual. Those who stay out on valuation grounds alone, as many did in the run-up to the dot-com boom, miss years of extraordinary gains. Those who enter without discipline suffer when the bubble eventually bursts.
The lesson endures. Process and discipline, not conviction alone, determine who prospers when price detaches from value. Irrational markets are not only a risk but also an opportunity for skilled investors with the right tools. The aim is not to predict the exact turning point but to participate with discipline and exit with gains secured.
KEY RISKS
Past performance does not predict future returns. You may get back less than you originally invested.
We recommend this fund is held long term (minimum period of 5 years). We recommend that you hold this fund as part of a diversified portfolio of investments.
The Funds managed by the Global Equities team:
- May hold overseas investments that may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of a Fund.
- May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings.
- May invest in smaller companies and may invest a small proportion (less than 10%) of the Fund in unlisted securities. There may be liquidity constraints in these securities from time to time, i.e. in certain circumstances, the fund may not be able to sell a position for full value or at all in the short term. This may affect performance and could cause the fund to defer or suspend redemptions of its shares.
- May have a concentrated portfolio, i.e. hold a limited number of investments or have significant sector or factor exposures. If one of these investments or sectors / factors fall in value this can have a greater impact on the Fund's value than if it held a larger number of investments across a more diversified portfolio.
- May invest in emerging markets which carries a higher risk than investment in more developed countries. This may result in higher volatility and larger drops in the value of a fund over the short term.
- Certain countries have a higher risk of the imposition of financial and economic sanctions on them which may have a significant economic impact on any company operating, or based, in these countries and their ability to trade as normal. Any such sanctions may cause the value of the investments in the fund to fall significantly and may result in liquidity issues which could prevent the fund from meeting redemptions.
- May invest in companies predominantly in a single country which maybe subject to greater political, social and economic risks which could result in greater volatility than investments in more broadly diversified funds.
- May hold Bonds. Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay.
- May, under certain circumstances, invest in derivatives, but it is not intended that their use will materially affect volatility. Derivatives are used to protect against currencies, credit and interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The use of derivatives may create leverage or gearing resulting in potentially greater volatility or fluctuations in the net asset value of the Fund. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead. The use of derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short-dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash.
The risks detailed above are reflective of the full range of Funds managed by the Global Equities team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
DISCLAIMER
This material is issued by Liontrust Investment Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518552) to undertake regulated investment business.
It should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets.
This information and analysis is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content, no representation or warranty is given, whether express or implied, by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID) and/or PRIIP/KID, which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.com or direct from Liontrust. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
David Goodman
David Goodman is a fund manager in the Global Equities team. David joined Liontrust in 2024 from GAM, where he was responsible for applying technical analysis to assist with portfolio construction and risk management.
