Do Valuations Still Matter?
For years, the debate has raged: how much do valuations really matter when it comes to the stock market?
Looking back over the past couple of years, the market has defied caution. Stock prices have surged faster than company earnings or revenues. That disconnect is why outlets like The Wall Street Journal have highlighted that today’s market looks even more expensive than it did at the height of the dot-com bubble. For example, the S&P 500 now trades at more than three times sales, nearly double the 25-year average.
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Headline ratios only tell part of the story. When we factor in Treasury yields — a key benchmark for discounting future earnings — the market looks stretched. Rising bond yields during the 2022 inflation surge drove our fair-value calculations down, even though corporate earnings kept climbing. Using a 10-year Treasury yield around 4.25%, the S&P 500 appears about 40% overvalued. That’s not as extreme as the late 1990s, when valuations were more than 60% above fair value, but it still raises red flags.
Why a Crash Isn’t Certain
Despite these lofty valuations, we’re not predicting a catastrophic 40% drop. If the market stumbled, the Federal Reserve would likely respond by cutting rates. At lower yields — say around 2.85% — valuations would look much more reasonable. From that perspective, the market seems closer to 20% overvalued, and we’re holding to a year-end target of around 5,200 for the S&P 500.
The “YOLO” Factor
It’s impossible to ignore the speculative fervor running through the market. Daily options trading has exploded, and investors have piled into the biggest technology names — many tied to artificial intelligence. Today, just ten companies account for nearly 40% of the S&P 500. That concentration echoes the tech mania of 1999, when investors convinced themselves stocks could only go higher.
The Economic Backdrop
Meanwhile, the broader economy sends mixed signals. Tariffs, reshoring efforts, and policy shifts are reshaping business decisions, but not without costs. Tariffs, after all, function as a tax, and they add friction to growth. On the productivity front, AI is the big unknown. Will it truly boost profits across industries — or simply cannibalize existing business models? The late 1990s offer a cautionary tale: technology eventually transformed productivity, but it took years before profits caught up to investor expectations.
So far, growth doesn’t suggest an economic boom. Real GDP in the first half of 2025 averaged just 1.4%, and job gains are slowing.
A Cautious Stance
Valuations matter because, over time, they tend to revert toward long-term averages. We’ve seen this lesson before: back in 1999, many believed recessions were a thing of the past. They weren’t. Today’s optimism around technology and markets may be overextended, too.
That doesn’t mean opportunity is absent. Beneath the surface of the S&P 500, many sectors and individual stocks look reasonably priced and attractive. Our view is simple: remain cautious on the largest and priciest names, and look for value where expectations aren’t already sky-high.
