12/14/25
S&P 500: 6827
Nasdaq: 23,195
10 Year Treasury: 4.1%
David R. Snyder, CFA
All valuation measures (price/cash flows, price/book, etc.) on the S&P 500 are at all-time highs except for P/E’s but we are at 2.5 standard deviations on P/E. Even median valuations are near all-time highs at a P/E of 19. The equal weight indices are lower than the median stock valuations because of more individual equity outliers on the low end. But even the equal weighted S&P 500 index is near its all-time valuation highs at a 17 P/E. The equity risk premium is negative, which has only occurred in the 1998-2000 period and right before the 1987 crash. On normalized earnings the 12 month forward P/E is about 25 vs. 30 in March of 2000 as we now have above trend earnings.
The highest growth in the economy is coming from the Mag 7 which makes up 37% of the S&P 500. That means the rest of the economy must be growing slower than in the past as there is only a finite amount of growth in the economy (earnings growth is correlated with GDP growth over the long term and GDP growth is lower now and will be even more so in the future than the last century due to demographics and less immigration). You can’t have it both ways. The biggest cap stocks have much higher growth than in the past. So the argument that the other 493 are relatively cheap is flawed. How are the other 493 cheap historically if they are growing a lot slower than they have in the past. For example, Amazon (AMZN 228) is valued at a 30 P/E while its retail competitors trade at lower relative historical P/E’s (relative to the S&P 500) as AMZN has doubled its retail share of retail spending over the last six years with retail share now over 10%. AMZN is capturing more than 20% of every incremental retail dollar spent. Thus, AMZN’s retail competitors are growing slower than before and also facing increased price competition. Why shouldn’t they have historically lower relative P/E’s?
Many investors believe the Mag 7 are going to slow down their growth and the other 493 are going to pick up their growth. Even if that happens the S&P 500 overall is going to decline because the Mag 7 dominate the index. Also the overall index would still be way overvalued as the median stock is near all-time highs at a 19 P/E.
Some investors argue that P/E’s were higher in the late 1990’s when both short and long interest rates were higher giving the current stock market more room to run. However the core PCE inflation rate averaged 1.5% from 1997-2000, compared to the much higher core PCE inflation rates of the last few years. Also expecting another 3 standard deviation event is not a good investment strategy as it happens only 0.3% of the time.
The P/E of the S&P 500 advanced from 9 in 2009 to 22 in 2022 (coincides with calendar years!) So one multiple point per year which of course wasn’t linear. But that is how secular bull markets work. In 2012 we were at an 11 or 12 P/E and profit margins and P/EBIT were at all-time highs. The sovereign debt crisis was solved, US banks were securely capitalized, corporate earnings had been growing rapidly since 2009, and interest rates were low. Job growth was 1.8 million (recovering 42% of jobs lost during the Great Recession) and GDP growth was 2.3%. There was a long runway ahead to get back to full employment. No way anyone could justify an 11 or 12 multiple then vs. 23 today. S&P 500 EBIT margins are only slightly higher today than in 2012. That is how secular bull markets work. P/E ratios expand slowly over a 15 to 20 year time period. Can you imagine if someone in 2012 said that the P/E should be 23 or if someone said today’s P/E should be 11 or 12. They would be laughingstock of the investment community. But they would be rational arguments. Status quo is so powerful.
If the S&P 500 today had the same P/E as in March of 2009, the S&P 500 would be 2772 instead of 6800. All of the increase above 2772 is just subjective valuation by investors. But subjective valuation has a very wide historical spread and we are at the very high end of that spread.
Valuations don’t correlate with short term returns, but correlate very highly with 10 year returns. A valuation model I use that has been made better by Cypress Capital shows the highest correlation with future 10 year returns. Since 1970, the average error for 10 year annual returns has been around 2 to 3%. Thus, if the model forecasts 5% annualized returns for next 10 years, the actual results with high probability would likely be between 3.5% and 6.5%. It has only been inaccurate during bubbles (the late 1990’s and of course the last couple of years). It has predicted 0% 10 year returns only three times, and that was in 2000, January 2022 and again now. The 2000 forecast was exactly right even though earnings doubled during that period but was completely offset by a halving of the P/E ratio. The correlation is linear, meaning that 7 year returns are more correlated than 4 or 5 year returns. So we are already about to enter year 5 for the 2022 call meaning there is likely to be more correlation with short term returns (over next 6 years) since we have only 6 years left for the 10 year correlation to happen. My expectation is for the S&P 500 with dividends reinvested to only have 0 to 3% compound annual returns and zero to negative low single digit real compound annual returns over the next 10 years.
The “toxic combo” of a P/E of 18 or above and and an unemployment rate below 4% (other than during wars) was triggered in December of 2019 and again in December of 2021. Historically the toxic combo has provided the absolute worst 10 year returns over the last 100 years. It was triggered in 1929, 1966, 1969, and 2000. So far the 12/19 trigger has provided decent returns but we are only in the first five years of that trigger. You make big money in stocks over the intermediate and long term when the unemployment rate goes from 10% to 4% as aggregate hours worked increases at double the rate of a constant unemployment rate, earnings go from below trend to above trend and when the P/E expands from 8 or 9 to 18 or higher if a bubble. It is that simple. We are as far away from this scenario as possible. We first dropped below 4% unemployment rate in 12/21 and have stayed at 4.4% or below since then. If we stay below 4.4% through December, it will break the 2/66-2/70 record for extended low unemployment in peacetime. We are on borrowed time. No way going to fall for the theory that cycles are obsolete.
The S&P 500 has never had positive 10 year returns with the Case-Shiller P/E ratio this high. In fact it has been a disaster in the past. Small sample but…. some argue that return on equity is higher than previous cycles and thus the valuations are justified. However, ROE is distorted as book value is artificially low because of massive buybacks above book value instead of reinvesting earnings. The result is an artificial boost to ROE. Also, the argument that book value should be higher because of R&D being expensed vs. capitalized and companies not carrying true brand value on balance sheet is flawed. First R&D is a very small percentage of book value and second, brand value is more valid with consumer companies (technology companies have risk of becoming obsolete dramatically higher than consumer companies) which are of lesser weighting in S&P 500 now. Finally, intangibles have been relevant for the last 40 years not just today. Even adjusting for these variables, price/book value is still near all-time highs.
A big issue is whether or not the higher P/E’s of the last 30 years are here to stay. This is a really big issue. Do we count the two bubbles (1997-2002 and the last few years) or do we ignore them as extraordinary events when calculating historical average P/E’s. The bubble years also include the two years after the bubble burst as valuations decline but are still at extremes, extending the number of bubble years in historical valuation measures. The valuations in 1999-2000 were a 3 standard deviation event (0.3% of the time). The historical median P/E (median for the S&P 500, not for individual components) is lower than the average because of more outliers on the high end. Without the twin bubbles, valuations really haven’t risen from the 20th century. From 3/09 until 2/20 (a full cycle) the average forward P/E was only 14.5. In order to justify higher valuations, higher earnings growth and/or steadier earnings growth is required. ROE is at historical highs but that is distorted and ROE is always highest at the end of a secular bull market. If ROE returns to its mean, earnings growth will be lower. Not buying the permanent higher earnings growth story. And certainly not buying the less volatile earnings growth story. In fact we have experienced way more extreme events in the last 40 years than the prior 40 years (1945-1985).
The argument has always been that the US economy was transitioning to a service economy where service companies are less cyclical and deserve higher valuations. But if that was the case then why did valuations not expand from 1945 until 1995 when the economy had already transitioned to mostly a service economy?
Full Disclosure: I own several of the securities mentioned positively. None have been purchased within the last month. The opinions merely represent the opinion of the author as CIO of Journey 1 Advisors, LLC and intended to inform the readers about our investment philosophy and strategy. The contents of this report are based on sources believed to be reliable. It is not intended for circulation. It is not intended to offer investment advice, or to recommend the purchase or sale of any securities or investment product. Investment advice is only given after a client has signed an investment advisory agreement with Journey 1 Advisors, LLC and will be subject to the terms and conditions therein. Your decision to buy or sell a security should be based upon your personal investment objectives and should be made only after evaluating the stock’s expected performance and risk.