Fear, FOMO or Fundamentals? A Forward-Looking Framework for Equity Allocations

From FOMO to Fundamentals

U.S. equity markets have delivered remarkable returns over the past 15 years. This has prompted many investors and advisors to ask whether they should increase allocations to avoid missing out on further gains, decrease them in anticipation of more muted returns or even prepare for a significant reversal.

We believe that both instincts — fear of missing out (FOMO) and fear of loss — are unreliable guides for making long-term investment decisions. Instead, we base our approach on fundamentals to develop a forward-looking analysis for determining strategic equity allocations.

First, we emphasize a core principle of portfolio construction: Long-term objectives and individual risk tolerance should drive strategic asset allocations, not recent market performance. Expecting what lies ahead to be like the road we’ve already traveled is like driving a car by looking in the rearview mirror.

This mindset may lead investors to add (or avoid) risk at precisely the wrong time. In our view, this is especially relevant in today’s environment, which has been shaped by exceptional U.S. equity returns, elevated valuations and intense enthusiasm for artificial intelligence (AI).

Decomposing Equity Returns

To understand what drives performance, we break total equity returns into three fundamental components:

• Earnings per share (EPS) growth

• Changes in valuation multiples

• Dividends

EPS growth is further broken down into revenue growth and changes in profit margins. This shifts attention away from recent price movements and toward the underlying economic drivers that ultimately determine returns.

Using this approach, we analyze what has driven U.S. equity performance since the global financial crisis. Our analysis shows that a significant portion of the S&P 500^® Index’s impressive returns from late 2010 through 2025 came from rising corporate profit margins and a substantial increase in price-to-earnings (P/E) multiples. In fact, valuation expansion alone accounted for about half of the market’s cumulative price return over this period — a contribution that cannot be repeated indefinitely.

We then explore why margins and valuations rose so dramatically and address how enthusiasm around AI — concentrated in a handful of large technology firms — has pushed P/E multiples for large-cap indexes well above long-term averages. We note that while the U.S. economy is a powerful engine of growth, neither profit margins nor valuations can expand forever.

Making Equity Allocation Decisions Using a Forward-Looking Fundamental Approach

1. Turning to what is likely to happen over the next few years, we consider two key questions for making equity allocation decisions:

2. Are earnings likely to grow significantly from here?

3. Are valuation multiples likely to rise further?

With earnings growth already elevated relative to history, today’s high P/E ratios leave little margin for disappointment, suggesting valuation multiples are more likely to shrink than to rise.

As we assess future market dynamics, we can envision three potential scenarios that could shape equity allocation decisions:

• A sharp reversion to the mean driven by falling margins and valuations.

• An upside scenario fueled by transformational productivity gains.

• A middle‑ground featuring stable margins but gradually declining P/E multiples.

Our base case aligns with the middle-ground scenario.

We believe a fundamentals-based approach points to attractive opportunities outside U.S. large-cap growth stocks. Non-U.S. developed markets, U.S. small-caps and value-oriented equities appear to be less exposed to valuation risk and are more reliant on earnings and dividend growth. Therefore, diversification is not a defensive posture; it is a rational response to opportunities across global equity markets.

We encourage investors and advisors to resist making decisions based on recent performance, AI-related excitement or regret about missed gains. By focusing on the fundamental drivers of returns — earnings, valuations and dividend growth — we offer a disciplined framework for forward-looking equity allocation decisions aligned with long-term investment goals.