Tightening not frightening

08 September 2026

• Equities’ long-term prospects intact, but rally justifies prudence
• Some modest profit-taking across equities and credit could improve portfolio resilience
• Short-dated bonds offer a safe haven of decent yields, with the flexibility to reallocate back to equities after any setback

One of the more common errors in portfolio management is conflating near-term tactical portfolio adjustments with a strategic change of view. Reducing market risk after strong market gains is not the same as abandoning equities. It is perfectly consistent and legitimate for investors to remain constructive on the long-term, structural case for stocks while becoming slightly more selective about the next few quarters. That distinction feels particularly relevant today as the current rally in equities, which arguably started with the unveiling of ChatGPT¹ in November 2022, approaches its fourth year (see chart 1 below).

Firstly though, the long-term case for equities remains compelling. Jeremy Siegel's famous observation that stocks have historically delivered superior real returns of 6.5-7% over the long term remains one of the most powerful principles in investing. The so-called ‘Siegel Constant’² reflects the remarkable persistence of long-run equity returns through wars, recessions, inflation shocks, political upheaval and countless market crises.

Intuitively, equities are a way to monetise human progress and innovation through the medium of the listed corporation. As such, The Economist newspaper stated earlier this year, “There is no other widely available, tried-and-tested asset class offering similar long-run returns.”

But acknowledging that equities are one of the best long-term wealth generators does not imply that investors should completely ignore valuations, sentiment or market positioning (although this may be suitable for those with the longest horizons). Markets are of course far from linear in their trajectories. Even within bull markets such as the present one, periods of exuberance can create conditions where modest rebalancing and profit-taking might improve future risk-adjusted returns.

Apart from anything else, it is impossible to know in advance when an equity ‘era’ might end, so banking some gains along the way can be an important source of additional value added for professional investment managers and their clients.

Today, there are signs that some over-enthusiasm may have become embedded in market pricing. While the fundamentals underpinning corporate earnings appear broadly healthy given the second quarter earnings season in the US (both Microsoft³ and Alphabet⁴ reported significant order backlogs for their cloud computing services), some valuation measures suggest a less generous prospective return environment than investors have enjoyed over recent years.

Indeed, valuations are often poor predictors of what happens next week but reasonably informative about longer-term return potential. When starting valuations are rich, future returns have historically been lower on average.

One useful gauge is the Shiller cyclically adjusted earnings (CAPE) ratio, which smooths inflation-adjusted earnings over a ten-year period to reduce the impact of economic cycles. Historically, elevated CAPE readings such as today’s 41x* reading have been associated with lower subsequent ten-year returns for the S&P 500, even though they are not a perfect short-term timing model.

In other words, extended valuations might not tell us exactly when markets will correct, but they do tend to say something about the returns investors can reasonably expect over the next decade. In turn, this should prompt at least some reflection about the sizing of the equity allocation within a blended or multi-asset portfolio.

As such, a trimming of equity exposure after a strong run can be viewed less as a market timing call and more as sound portfolio management. It is simply recognising that significant gains have been earned and that the balance between risk and reward is not quite as appealing as it was previously.

Chart 1: AI Boom - not necessarily the end of an era yet, but not the start either

Importantly, ‘modest’ is the watchword. This is not an argument for wholesale de-risking or for attempting to sidestep every bout of volatility in the style of a hedge fund. Rather, in the multi-asset context it is a case for incrementally harvesting gains, perhaps from areas of global equities which are less likely to defend themselves well in the event of a market downturn. Such adjustments allow investors to respect the long-term equity premium over unallocated capital while acknowledging that near-term market conditions may potentially be becoming less forgiving.

This same logic can be applied elsewhere in multi-asset portfolios. Credit spreads, the additional yield offered by lending to corporations over the yield offered by government bonds, remain relatively compressed by historical standards. While corporate fundamentals have generally remained supportive, investors are often not being paid substantially more for assuming incremental credit risk than they have in calmer periods. For example, the Bloomberg US Liquid Investment Grade average spread is currently just 0.9%* as at 18 August.

As a result, a modest reduction in lower-quality credit exposure seems sensible, particularly if the objective is to preserve flexibility rather than expressing a strong macroeconomic view. And supposedly rock-solid government bonds are not immune to scrutiny either. There, yields have adjusted materially higher over recent years with interest rate volatility apparently now a feature rather than a bug of the current investment environment as the market grapples with inflation and geopolitical uncertainty. For investors carrying this so-called duration risk, a modest reduction can help improve portfolio resilience against the risk of bond yields jumping up further on the back of another bout of inflation or policy-related uncertainty.

Chart 2: Who knew – government bonds have become a source of portfolio volatility recently

Taken together, these moves amount to a modest tightening-up of overall portfolio risk exposure. Far from a retreat or defensive posture, they represent a recognition that after a substantial rally across risk assets including bonds and credit, the possibility of a repeat of these gains starts to diminish.

Looking ahead, there are reasons to suspect the fourth quarter could prove choppier. Valuations as mentioned are extended on some measures, the Iran war remains a huge source of uncertainty (at the time of writing the US President had just threatened to bomb long-term ally Oman), the inflation and interest rate outlook are uncertain amid high oil prices and a newly reactive Federal Reserve.

Finally, investors continue to demand evidence that the investment in AI is paying off as expected. Together, these factors potentially leave markets vulnerable to periodic setbacks, even if the longer-term outlook remains constructive.

The question then becomes what alternatives are open to investors? The encouraging news is that they are no longer forced to leave proceeds sitting idly in cash. For example, short-dated bonds today offer yields that are attractive in both absolute and historical terms, with US dollar and sterling investors enjoying yields of 3.7% and 3.9%* respectively, both ahead of inflation. Investors can therefore earn real income while maintaining liquidity and reducing overall portfolio volatility. In many cases, reallocating a portion of profits from equities, credit and duration into high-quality short-maturity fixed income provides a rare combination of respectable yield, capital preservation and future optionality. That optionality may prove particularly valuable if market volatility creates more attractive entry points further down the road, even if market volatility in the last few years has proven short-lived (the S&P 500 took barely two months to recover from the tariff announcements of Liberation Day in spring 2025). A more sustained equity correction would doubtless be painful, but the real opportunity lies in re-engaging in stock markets in the aftermath.

In summary, long-term investors do not need to become structural pessimists simply because markets have had a strong run. The enduring logic behind the Siegel Constant remains intact, not least because it is net of all the volatility equities have historically exhibited.

Equities are still likely to be a key engine of long-term return creation. But when stocks have surged and valuations are elevated, forward return expectations mechanically become more modest.

As stock markets, particularly in the US, appear increasingly priced for good news, there is nothing inconsistent about taking some chips off the table.

Profitable decisions and careful risk management are often less about dramatic changes of direction and more about minor adjustments to exposures. In this way, the professional multi-asset investor and their clients can maintain participation in long-term growth while improving the portfolio's resilience in navigating whatever the next few quarters may bring.

Julian Howard is Chief Multi-Asset Investment Strategist at GAM Investments. This article represents the views of GAM’s Multi-Asset team.