12/14/25
S&P 500: 6827
Nasdaq: 23,195
10 Year Treasury: 4.1%
David R. Snyder, CFA
There are many reasons that the P/E of the stock market should be lower not higher based on secular changes. First the US deficit is over 100% of GDP and expected to worsen over the next 10 years. There is a correlation of equity valuations worldwide with debt/GDP ratios when they exceed 100%. The lowest P/E for the S&P 500 in the last 100 years was in the late 1940’s when the debt to GDP ratio was similar to today’s ratio. Although Rogoff was wrong about countries growing significantly slower when their debt/GDP ratios exceed 90%, there is evidence that GDP growth is about 0.5% lower per year when debt/GDP is 90% or higher. Crowding out private spending is one cause of the slower growth. And the higher the debt/GDP ratio rises above 90%, the slower the growth. Also there is a risk that vigilantes cause governments to reduce fiscal stimulus for many years as was the case in Europe after the European sovereign debt crisis. This would slow economic and earnings growth.
We now have a pandemic risk that wasn’t priced in to stock market before Covid and certainly not priced in today. With population becoming more dense and world travel increasing, there is more likely to be more pandemics in the future. We won’t be able to stimulate the economy with 8 trillion dollars of fiscal and monetary spending in the next pandemic. There is no discount for future pandemics.
Global warming is a real issue. Not being political here just facts. We are on our way to 2.5 to 3 degrees Celsius higher by the end of the century instead of the 1.5 degree goal, which will be devastating. Both the heat and the rise in sea levels of at least a few feet will hamper economic growth. 30% of the world’s population lives within 100 miles of the coast and most of the US wealth is on the coasts, which will be severely negatively affected by rising sea levels. There have been 62% more extreme climate events this past decade than in the 1980″s. 60% of the $182 billion of climate related property/casualty losses in 2024 were uninsured and the trend will continue as properties become uninsurable or too expensive to insure. This is going to become a real negative for economic growth in the next 10 years. The most accepted model forecasts unabated carbon emissions will cause global GDP per capita to be 23% lower by the end of the century then it would be without climate change.
Trump is reducing public R&D spending significantly. The 21% reduction in non-defense public R&D spending will reduce GDP by 3.4% in the long run according to one study. R&D increases productivity which increases real wages, return on investment, which then increases investment. A 25% reduction would make an average American $5000 poorer.
R&D spending accounted for 20% of productivity growth since 1948. One dollar of federal R&D spending increases private sector R&D by $.25. Each additional dollar of non-defense federal R&D spending increases GDP by an average of $11.50 in present value terms over 30 years. The R&D spending reduces the federal deficit over 30 years even if financed by debt.
The founder of AI recently said that there is a 10 to 20% chance of human extinction within the next 30 years. That means there is probably a 30 to 50% chance of events leading to as much one third of the population dying. The stock market is way underestimating the threat of AGI leading to nefarious activities. There will be a need for a massive amount of regulation that will slow down AI. We will surely have more calamities that will affect economic growth. We have never had this kind of risk before. There is no discount in the stock market for this risk.
There have been significantly more volatile economic and financial events in the last 40 years than in the prior 40 years. We had declines in the S&P 500 of 58%, 50%, two 35%, 26% and five 20% or more at least intra-day in the last 40 years, significantly more than from 1945-85 period. We also had more extreme events and bubbles, starting with the savings and loan debacle in the late 1980’s. Why would that lead to a higher P/E today? More volatility especially with regard to extreme losses argues for a lower P/E.
With all of the new technology for investors we are seeing much higher retail participation and trading, creating more volatility and bubbles than in the past. The unprecedented amount of fiscal and monetary stimulus over the last 30 years has also contributed to higher valuations, volatility and bubbles. This is unlikely to last as we have run out of ammunition.
One of the biggest drivers of economic growth and earnings growth over the last century has been population growth. Last century population growth averaged about 1.3% from 1945 to 2000 and is now growing about 0.6%. Population growth will continue to decelerate in the future with some estimating that world population growth ends by the middle of next decade. In any case it will slow down significantly over the next 30 years. It is even worse in the US and other developed countries. Deaths are expected to exceed births within the next five years in the US. And with immigration coming to a halt, there will be very little population growth in the next 20 years. Demographics (baby boomers retiring) make the labor force future growth even worse. And the labor force grew at a 1.7% annual growth rate from 1965 until 2000 due to population growth and the dramatic increase in female labor participation. The prime age participation rate is now near all-time highs and is not likely to go much higher. GDP growth is just hours worked plus productivity. The US is now going to rely almost solely on productivity growth for GDP growth. Nominal GDP growth is highly correlated with S&P 500 earnings per share (EPS) growth. Since 1947 EPS has grown 7.7% annually while the economy has grown 6.4% annually. The S&P 500 does get a slight boost from higher international growth as 35% of profits are from foreign countries. GDP growth is going to be lower in the future so why wouldn’t EPS? Why should the US have its highest historical valuations with this backdrop.
When population growth (labor force growth) drives GDP growth, the logical thinking is that many new business are created that are not in the S&P 500 which would therefore take away some of the potential growth in S&P 500 earnings (i.e. the boost from faster GDP growth is not proportionate to growth in S&P 500 earnings). But history reveals that this has only a minor negative effect on S&P 500 earnings growth.
The great transfer of wealth over the next 20 years from baby boomers to Millennials has been cited as a major tailwind for the economy and stocks. The theory is that Millennials will spend more of their inherited wealth than their parents stimulating the economy and/or that they will allocate more of the assets to equities vs. bonds, boosting the stock market. There is an estimated $80 trillion of baby boomer wealth that will be transferred by 2045 and $19 trillion of that is real estate wealth (mainly personal homes). Charitable donations will subtract about 15% or $12 trillion. The equity portion of this transfer is about 50% overvalued. Thus the $52 trillion in baby boomer equity investments are really only $34 trillion using average historic valuations. Also, most baby boomers have similar equity allocations as Millennials (unlike the silent generation to baby boomer transfer), so there will likely won’t be much net increase in equity flows by Millennials. The median retirement savings for baby boomers is only $185,000. The average boomer has only $130,000 of home equity. Two-thirds of baby boomers will face income challenges. Thus the great wealth transfer will be very concentrated in the ultra wealthy whose offspring will invest very similar to them with the exception of possibly more alternatives such as private equity (which eventually becomes public equity). The top 1.5% will transfer 40% of the Baby Boomer wealth. Thus, this transfer will not be a big tailwind to the economy and the stock market over the next 20 years.
A big driver of earnings growth and higher margins has been the decreasing share of labor income as a percentage of revenues since the 1990’s. This has begun to reverse and will no longer be a driver of margin expansion. Labor share has declined from 64% to 57% over the last few decades. With lower GDP growth and likely higher share of labor of GDP, the only way earnings are going to grow at a higher rate (adjusted for buybacks) is for productivity to grow much faster than historical rates.
The composition of the S&P 500 also should make the S&P 500 more volatile leading to lower valuations over the long term. Info tech is now 35% of the S&P 500 vs. 6% in 1992. Communication services replaced telecom (about 10% each) but its components are much more cyclical (TTD, PTON, etc.) today. Staples have declined from 14% of S&P 500 to 5% today. Financials are 13% today vs. 10% in 1992. This has not been fully offset by the decreased percentage of consumer cyclicals (10% vs. 14%), industrials (8% vs. 13%). energy (3% vs. 10%), materials (2%vs. 7%), and utilities (2% vs. 5%). Theoretically the S&P 500 should be more volatile based on its components. Yes, technology is still a very cyclical sector. The Covid recession has falsely led investors to believe it is not as that was not a normal recession. Fascinating that during the 2022 26% bear market and the 20% intra-day bear market this year, low volatility became even more low beta to offset the higher volatile sectors. For example, I manage some growth and income portfolios and they were actually up on average low to mid-single digit percentages in 2022 and were fully invested in equities. This is because the healthcare, utilities, staples and other low vol sectors had even lower than historical betas that year. This dynamic also occurred early this year. But will this change in low vol betas continue in the future, especially in a recession? And of course we haven’t had a normal recession since these more volatile sectors have gained significant weight in the S&P 500. All things equal this should lead to a lower P/E due to higher potential volatility of the overall index.
The Mag 7 which make up about 35% of the S&P 500 are not more reliable earnings growers than the rest of the S&P 500. In 2022 most of the Mag 7 had negative earnings growth and we didn’t even have a recession. Just wait until there is a recession. Nividia (NVDA 268) saw earnings decline 33% year over year starting in the July 2022 quarter and lasting for four quarters (one year). Alphabet’s (GOOG 279) earnings fell in 2022. Amazon’s (AMZN 244) earnings dropped a whopping 50% in 2022. Meta’s (META 621) earnings declined by 38%. Microsoft (MSFT 494) and Apple (AAPL 265) had three or four quarters of flat to down earnings growth beginning in the middle of 2022. The average drawdown of the equities of the Mag 7 from each of their highs in 2021 to their respective lows in 2022-23 was 56%. Without a recession! Advertising is one of the most cyclical areas of the economy and META and GOOG are highly exposed.
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.