S&P 500 Valuations: Risk or Refinement for Growth Continuation?

The S&P 500's valuation picture remains stretched as of November 2025, with the Shiller cyclically adjusted price-to-earnings (CAPE) ratio hitting 39.42. That figure represents a 4.53% annual climb and a 0.78% monthly jump, far exceeding the historical average range of 16 to 25. While the metric's 10-year inflation-adjusted earnings smoothing dampens sensitivity to near-term growth swings, it also prolongs the market's exposure to potential corrections if underlying fundamentals falter.

Modern payout policies-particularly aggressive share buybacks-further complicate valuation interpretation. Robert Shiller's adjusted total-return CAPE model tries to account for these shifts, but buybacks can distort earnings growth perceptions and inflate price-to-earnings multiples according to Shiller's data. Investors thus face a dual challenge: navigating an environment where stretched valuations demand patience, while also reconciling traditional metrics with today's capital return dynamics.

The CAPE's elevated level suggests a market betting heavily on sustained economic optimism. Yet its historical tendency to anticipate lower long-term returns means caution is warranted. Earnings growth will need to justify the premium-if not, the 10-year smoothing could delay recognition of true valuation risks, leaving portfolios exposed to eventual mean reversion.

Growth Engine: Earnings Momentum and Sector Leadership

Earnings growth in Q3 2025 is proving remarkably broad-based and resilient. The S&P 500 is tracking toward 14% EPS expansion, led by the "Magnificent 7" tech darlings posting 21% EPS growth and the IT sector powering ahead with 40% EPS gains. This isn't just a tech-sector phenomenon - AI adoption is now lifting utilities and industrials, creating wider earnings momentum.

The market is increasingly pricing concrete earnings strength rather than speculative valuations. AI-driven returns are shifting from multiple expansion to fundamental-driven performance, with 85% of companies beating EPS estimates yet seeing intensified reactions to misses. This discipline reflects growing sophistication but also heightened sensitivity to expectations.

However, this growth has friction points. The rapid rotation into AI winners has created valuation pressures, with narrow leadership raising dispersion concerns. Recent pullbacks after earnings highlight how quickly expectations can sour when momentum stalls. While AI adoption appears sustainable across sectors, the speed of market reactions suggests investors remain hypersensitive to any sign of slowing momentum in these high-flying areas.

Cycle Dynamics: Risk Assessment and Growth Continuation

The market's current markup phase reflects sustained institutional buying and new investor participation, as outlined in the classic four-stage cycle framework. During this phase, rising prices and volume typically signal growing confidence-though elevated metrics like the Shiller CAPE ratio now hover near historic highs.

The S&P 500's 39.42 CAPE ratio as of November 2025 underscores investor optimism about earnings growth, even as it stretches well above long-term averages. This valuation premium hinges on expectations of robust corporate profitability, particularly from AI-driven firms and tech leaders. However, such optimism carries inherent risks: the ratio's current level has historically preceded lower long-term returns if earnings fail to justify the premium.

Still, the markup phase isn't inherently terminal. Institutional behavior during this stage-gradual accumulation followed by broader participation-suggests momentum may persist unless earnings growth decelerates sharply or macroeconomic headwinds intensify according to Schwab's analysis. Corrections remain possible, but they're often refinements rather than reversals, trimming overextended positions without triggering a full markdown.

Key risks to monitor include potential earnings disappointments in high-CAPE sectors and rising real interest rates, which could pressure valuations. Yet these challenges align with typical markup-phase dynamics: volatility often peaks as late-stage euphoria emerges, only to subside once pricing stabilizes. For now, the cycle's logic remains intact-but vigilance is critical as the market balances growth aspirations against stretched valuations.