Overview: What stretched valuations mean for investors

So what does this mean for investors? Given that valuations in certain parts of the market do look stretched, investors may need to shift strategies from what worked last year. Here are three moves to consider:

1. Go for value. Rather than chase last year’s winners – a poor strategy year-to-date – investors should consider embracing some of last year’s losers and adopting a general bias toward value-oriented areas of the market, as many investors do appear to be doing. Year-to-date, U.S. value stocks advanced roughly 2.1 %, while U.S. growth equities are flat.

2. Overweight large and mega cap stocks. As I’ve long been advocating, I believe that investors should consider trimming their allocations to small cap stocks in favor of gaining greater exposure to large and mega cap names. To be sure, large cap names are no longer cheap. U.S. large caps, for instance, finished March at 17.25x trailing earnings, comfortably above the 60-year average and the highest level in four years. Yet large caps names have still gained around 1.5% year-to-date, while small caps are down nominally on the year.

Market Realist – As the following graph shows, large caps have outperformed small caps (IWM) this year. The year-to-date (or YTD) returns of the S&P 500 (SPY) stand at 7.93% and the S&P Small Cap 600 (SML) has yielded returns of 0.49%. Data compiled by Bloomberg shows that an average of 381 S&P 500 stocks have increased during each of the last five years, compared to 311 in the 1990s. All but 40 companies were up in 2013—the most in at least two decades.

3. Embrace international markets. As I’ve been noting for some time, emerging markets (EEM) can offer compelling long-term value. In the developed world, meanwhile, I like Japan (EWJ) and the eurozone. While Japanese stocks have struggled this year, European equities have outperformed U.S. stocks. And though both Japan and Europe are less profitable, and are likely to grow slower, than the United States, they both possess one characteristic in short supply locally: value.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets, in concentrations of single countries or smaller capital markets.

Funds that concentrate investments in a single sector will be more susceptible to factors affecting that sector and more volatile than funds that invest in many different sectors.