S&P 500 Valuations: New Normal or Bubble? Strategists Debate

American bank strategists have suggested that the high valuation of the S&P 500 index may be a "new normal" rather than a bubble. Historically, the U.S. stock market has seen remarkably high valuations. However, upon closer examination, these high valuations might not be entirely unfounded.

The strategists, led by the head of stock and quantitative strategy, noted that based on 20 internal indicators they track, 19 of them show that the S&P 500 index is statistically "overvalued," with four indicators reaching historical highs. The report highlights that certain intrinsic characteristics of the S&P 500 index components, such as lower financial leverage, smaller earnings volatility, higher efficiency, and more stable profit margins compared to previous decades, support the current high valuations.

This analysis contrasts with another perspective on Wall Street, which compares the current high valuations to the "internet bubble" that burst at the turn of the century, warning of the risk of a repeat bubble. The strategists argue that the S&P 500 index has undergone significant changes compared to the 1980s, 1990s, and the early 2000s. They suggest that the current valuations should be viewed as a new normal rather than expecting a return to past levels.

Despite risks surrounding tariffs and their impact on growth and inflation, the S&P 500 index has surged over 30% since hitting its year-to-date low on April 8. The index has also shown a steady upward trend, with no single-day decline of more than 2% in 108 consecutive trading sessions, marking the longest such streak since July 2024.

This week, the 12-month forward price-to-earnings ratio of the S&P 500 index briefly reached 22.9 times. Since the beginning of the century, this level has only been exceeded in two periods: during the "internet bubble" era and in the summer of 2020, when the Federal Reserve cut interest rates to near zero due to the COVID-19 pandemic.

The strategists also pointed out that based on the ratio of the total market value of the S&P 500 index to U.S. GDP and various price-to-earnings ratios, the index has never been as expensive as it is now. However, they argue that this is not the whole story: the current composition of the S&P 500 index is of higher quality compared to previous decades, and its prospects may be brighter in the context of the Federal Reserve's rate cuts.

While buying stocks at the current valuation levels may feel uncomfortable, the strategists suggest that synchronized growth in sales, earnings, and GDP could alleviate this seemingly unsustainable situation, providing support for the high valuations. They add that in an environment where major economies maintain loose fiscal policies and the Federal Reserve implements rate cuts in a context of expanding and accelerating corporate earnings, finding reasons for such prosperity is not difficult.

In their view, the likelihood of this outcome occurring by 2026 is higher than the scenarios of stagflation or recession.