The stock market’s at record highs and, on the surface, everything looks rosy. But beneath the headline numbers, a growing number of institutional analysts are sounding the alarm.
And with AI-related valuations looking increasingly stretched, now might be a smart time to start preparing for the worst. Here’s how…
Is a crash coming?
The concern centres on concentration risk. The S&P 500‘s recent rally has been driven almost entirely by a handful of mega-cap technology companies. And with the Shiller CAPE ratio sitting well above 40 (the highest since the dotcom crash), the market’s seemingly pricing perfection.
Capital Economics has warned that if AI fails to deliver a return on investment at the pace investors currently expect, the index could correct by as much as 30% from peak to trough!
However, it’s important not to panic.
The same analysts note that corporate earnings remain robust, economic growth looks healthy, and AI enthusiasm may continue to push equities higher before any reversal arrives. In other words, these record highs could be entirely justified if earnings catch up.
Nevertheless, regardless of whether a correction materialises, having a plan is simply good investing practice.
That means keeping an emergency fund topped up, hold a cash buffer to protect against volatility, capitalise on any potential buying opportunities, and ensure your holdings are diversified enough to stay within your personal risk tolerance.
And for those who’ve already ticked off those boxes, there are still plenty of opportunities to explore, even in today’s frothy market.
One contrarian idea to consider
Indeed, there are pockets of genuine value well away from the AI frenzy. Trex Company (NYSE:TREX) is one I’m taking a closer look at.
As a quick introduction, Trex designs and manufactures composite decking and railing products. It has no meaningful connection to AI infrastructure spending, potentially making it a natural diversifier in any portfolio concentrated in tech.
Looking at its first quarter results, the business firmly beat expectations. While revenues only climbed 1%, that was notably better than what many analysts were projecting. And it’s a similar story for the group’s adjusted earnings per share, which shot up 16.1% ahead of consensus.
Subsequently, the stock’s up over 27% since the start of the year – outpacing the S&P 500 by a wide margin. And yet with a price-to-earnings ratio of 25, Trex shares remain relatively cheap compared to the wider market.
So what’s the catch? The main investment risk is macroeconomic sensitivity.
