Apart from providing useful definitions of a bubble and an anti-bubble, perhaps the most important part of our 2018 article was our discussion of “So What?” Far from an apathetic disregard of the situation, we gave actionable advice on steps to prepare investor portfolios for the potential bursting of the bubble. These still apply. Our recommendation 15 months ago was to reduce exposure to bubble assets; avoid cap-weighted index funds, which inherently overweight bubble assets; seek exposure to anti-bubble assets or markets that are implausibly cheap; and invest in value-based smart beta strategies, especially in Europe and the emerging markets.

Avoid bubble assets and markets. We have already addressed the current environment for cryptocurrencies, and despite today’s much lower prices, we see little to justify a floor of fundamental value. Our recommendation remains to avoid. We can say the same for Tesla: while the stock has come off its highs, its valuation remains at a point well above that justified by even optimistic expectations of future cash flows. Thus, avoid.14

US technology stocks remain a more nuanced case. As we noted a year ago, Apple and Microsoft flunk our definition of a bubble. In order to justify current valuations, using a discounted cash-flow model (or other valuation model), an investor needs only make aggressive, not implausible, assumptions. Additionally, the marginal buyer includes plenty of investors who rely on a valuation model as part of their decision process. The same cannot as easily be said for Tesla, Netflix, Tencent, or Twitter. The stocks of these companies all arguably qualify as being in bubble territory per our definition. Some even qualify as a “zombie” company, a company with EBIT less than its interest payments. A zombie company needs new capital just to pay the interest on its debt, let alone the contracted principal payments. Others, like Amazon, might or might not currently qualify as bubble stocks; we could make the case either way.

Even in a turbulent market, most of these tech stocks are trading at valuations nearly as rich as they have ever traded. The volatility in the fourth quarter of 2018—and in recent weeks—should serve as a strong reminder of the risk inherent in any investment strategy: the assumptions a strategy is based on must be right in order to derive long-term profit. Bubble-level expectations require near-perfect execution. Another consideration is that many of the new tech companies, notably Alphabet and Facebook, derive their revenues from advertising. The narrative—that these advertising budgets will not be cut in a downturn—is an untested, and perhaps very dangerous, assumption. Advertising is almost always one of the deepest spending cuts in a slowdown or recession.

Is the rebound so far in 2019 a chance for investors to exit prior to a larger drawdown, similar to the opportunity offered investors in dot-com stocks in May 2000? Of course, we don’t have a crystal ball, but we would recommend not betting on the momentum continuing nor on trying to score a big win with a short position. Rather, we prefer to take the simple step of just avoiding the bubble assets we have identified. We interpret the market’s decline in May 2019 not as the end of the story, but as another warning as to what can and likely will happen.

With this in mind, investors also need to be wary of market cap-weighted indices. Because these indices tie their constituent weights to market prices, they take on ever-increasing bets in overvalued securities. As bubble technology stocks have come to dominate the world’s list of largest companies, cap-weighted indices are making de facto bets that these growth-oriented companies can increase their valuations in the face of a slowing economy. Investors can reduce their exposure in this space by turning to smart beta strategies, especially those with a value orientation that breaks the link between prices and portfolio weights.

Find anti-bubble assets and markets. Although an anti-bubble in an individual stock is exceedingly rare, an anti-bubble in a sector or market is more common than most observers might think. Consider the depths of the global financial crisis in 2007–2008. Could the value of any single bank have gone to zero, making any stock price too high? Yes. But could the economy survive without a financial sector? Not really. Going to zero for a sector is highly implausible. Did each bank that failed create an easier environment for the survivors to prosper, a clear runway for them to take off? Yes. Did margins improve for the survivors? Yes. Financial services and consumer discretionary stocks in early 2009 were an anti-bubble. And we said so at the time.

We see a similar situation for value-based smart beta strategies outside the US market, particularly in emerging markets. While emerging markets as a whole trade at much more attractive valuations than the US markets, value strategies within the emerging markets space are poised to deliver an additional 2% to 4% performance advantage over their cap-weighted counterparts.15 A frothy top in the US market doesn’t mean investors need to avoid equity beta altogether, but rather seek out more attractive alternatives to source that equity risk, especially in markets where valuations stack the odds in investors’ favor.

One particular area of emerging markets falls squarely into the anti-bubble camp: unloved and shunned emerging market state-owned enterprises (SOEs). Many investors choose not to own them at any price. Yet many of these entities are earning substantial profits and are trading at levels that require implausible projections to not meet the future cash flows priced into their shares. Yes, there is a real risk of the state expropriating some of those cash flows, but if these SOEs wish to maintain continued access to the global capital markets, they need to continue to return some of the profits to external shareholders. The SOEs and governments that most support growing shareholder rights and the rule of law will be best able to expand their access to global markets.

A representative index of SOEs is not available. Therefore, we made a list of the top 50 SOEs in the emerging markets and examined the valuations of the group. The top 50 are a concentrated portfolio, with over two-thirds of the portfolio’s weight by market cap in Chinese companies, over half in the financial sector, and nearly a quarter in energy. Even so, the value is compelling. These 50 SOEs pay a weighted-average dividend yield of 4.19%, offering a bit of a safety net along with a likely large risk premium. Compare those characteristics to the broad-based MSCI Emerging Markets Index (which includes all of the 50 SOEs as a subset) which has a dividend yield of 2.75%, a modest premium to the MSCI ACWI’s 2.49% yield. This group of SOEs trades at a weighted-average price-to-book (PB) ratio of 1.03, a 36% discount to the MSCI Emerging Markets Index’s PB of 1.61, and at a price-to-earnings (PE) ratio of 8.9, 34% lower than the 13.5 PE of the broader group.

What would it take for one or more of these 50 SOEs to not deliver a substantial risk premium over the next 10 years? The enterprise would have to slash its dividends and stagnate or become materially cheaper. These are large, productive enterprises sitting at the center of strongly growing economies and they currently represent real value. The risk is that the value stops flowing to overseas shareholders—certainly not out of the question, but in our view an implausible outcome.

Within developed markets, we see the turmoil over Brexit potentially creating an anti-bubble opportunity in UK shares, especially if a hard Brexit becomes the odds-on scenario. The MSCI UK Index offers a dividend of 4.52%—even higher than the dividend yield of our basket of emerging market SOE stocks. The market is pricing UK stocks at 13.8x earnings, a full 25% discount to the MSCI World level. UK share prices have been essentially flat since the United Kingdom’s 2016 referendum in which voters opted to leave the EU. Brexit would need to destroy quite a bit of value in order to nullify this compelling risk premium. An overhang of uncertainty is keeping the discount in place. The capital markets hate uncertainty. A resolution in either direction will reduce the uncertainty and should encourage some capital flow back into the UK markets. Investors waiting for that clarity will miss the opportunity.