How to buy the right stocks when markets are high

Fear-of-missing-out is one of several emotions swirling through US markets after a run that has seen the S&P 500 index post its best run of weekly gains since 1989.

The leading benchmark is up 40% since October 2022, fuelled lately by NVIDIA Corp (NASDAQ:NVDA)-led excitement over artificial intelligence (AI) adoption as well as solid earnings and the prospect of looser monetary policy.

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Magnificent Seven stocks, which also include Apple Inc (NASDAQ:AAPL), Amazon.com Inc (NASDAQ:AMZN), Meta (NASDAQ:META), Tesla Inc (NASDAQ:TSLA), Alphabet (NASDAQ:GOOGL) and Microsoft Corp (NASDAQ:MSFT), are up by 140% on average over that same 17-month period.

Analysts at Deutsche Bank point out that another positive S&P performance this week would make it 16 gains out of 18 weeks for the first time since 1971, a joint record since the index’s formation.

The S&P 500 has already registered 13 all-time highs this year, a period when the index has added more than 6% in contrast to 1.5% for the MSCI All Country World ex-US index.

UBS Global Wealth Management told clients last week that a sense of unease can often override the optimism, excitement and exuberance of such bull market conditions.

Chief investment officer Mark Haefele said: “­Those sitting on paper gains wonder whether it’s time to realise profit, and those holding excess cash alternate between feelings of FOMO (fear of missing out) and FOLO (fear of losing out).”

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Dealing with these emotions, he said, required keeping a strong focus on strategy as well as tactics. UBS said investors still need to have a core allocation to US large-caps but with many portfolios increasingly dependent on only a handful of highly valued companies this should represent one of four building blocks.

Haefele added: “We believe that the right balance of US large-caps, international and small-cap stocks, quality bonds and alternative assets can allow investors to position for long-term returns while navigating near-term risks.”

The bank believes artificial intelligence will be the growth theme of the decade and that revenues from its adoption will grow around 70% a year until 2027.

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It points out that last year’s earnings from the Magnificent Seven were already around $340 billion (£268.3 billion), only slightly less than the sum earned by all Swiss and UK companies in the SPI and FTSE 100 index, and that this could rise a further 20% this year.

UBS said: “In our view, investors can’t afford not to have at least some exposure to AI. We believe software and semiconductors offer the best way to gain exposure.”

The bank’s base case is for the S&P 500 to trade moderately higher than current levels by the year-end, although a Goldilocks outcome for growth, inflation and interest rates offers the potential of 5,500.

The S&P 500 trades on a forward price/earnings ratio of 20 times, driven by the technology sector on 28 times. However, UBS believes tech valuations are fair given the very strong earnings growth expected in the coming years.

For those underinvested in large-caps, Haefele said building up exposure after such a large rally can be psychologically challenging.

He added: “Investors looking to mitigate timing risks can consider phasing investments on a disciplined schedule while accelerating during market sell-offs.

“Strategies that offer a degree of capital preservation can also help investors get upside exposure while mitigating their fear of regret.”