The Rebound Is Now Overdone: Overvaluation and Risks Ahead

The U.S. stock market’s recent rally has pushed valuations to extreme levels, with key metrics signaling a rebound phase that has likely extended beyond sustainable limits. As of May 2025, the S&P 500’s short-term technical gains face mounting headwinds from overvaluation, macroeconomic fragility, and sector-specific vulnerabilities. This analysis explores why investors should brace for a correction and pivot to defensive strategies.

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Valuation Metrics Paint a Bleak Picture

The Buffett Indicator, a widely followed gauge of market valuation, stands at 179.3% as of April 2025—significantly overvalued by historical standards. This metric compares total market capitalization to GDP, with readings above 159% signaling extreme overvaluation. The current level is only slightly below its late-2024 peak of 204.8%, the highest in history. Even the modified version of the indicator, which factors in the Federal Reserve’s expanded balance sheet, sits at 146.1%, still elevated enough to warrant caution.

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Technical Indicators Signal Fatigue

The S&P 500’s eight-day winning streak in early May 2025 marked its longest since 2004, but this rally has been shallow. The index broke above its 50-day moving average for the first time in months—a positive short-term signal. However, resistance at the 200-day moving average (~5,783) and mid-March highs has yet to be overcome. Technical analyst Katie Stockton of Fairlead Strategies warns that the rally lacks sustainable momentum, with longer-term trends remaining weak.

Sector Dynamics: Winners and Losers

The rebound has been uneven. Tech stocks have led gains, fueled by AI-driven earnings reports from Microsoft (+8%), Meta (+4%), and Nvidia (+2.5%). These companies’ AI investments—such as Microsoft’s $80 billion fiscal 2025 infrastructure spend—have drawn investor optimism. However, tariff-exposed sectors like consumer goods and utilities are struggling.

• Becton Dickinson (BDX) plunged 18% after cutting profit guidance due to tariffs.
• Eli Lilly (LLY) fell 12% on acquisition-related charges, while Qualcomm (QCOM) dropped 9% amid weak sales forecasts.

Economic and Policy Risks Loom Large

1. Tariff-Driven Uncertainty: President Trump’s trade policies continue to disrupt supply chains. Apple, for instance, now plans to shift iPhone manufacturing to India to avoid $900 million in tariff costs.
2. Recession Odds: Morningstar forecasts a 40–50% chance of a 2025 recession, citing slowing GDP growth (1.2% projected) and elevated inflation (core PCE to hit 2.6% in 2026).
3. Interest Rate Pressure: The 10-year Treasury yield rose to 4.22%, squeezing corporate profits and consumer spending.

Investment Strategy: Pivot to Defensives

Given the overvaluation and risks, investors should:
- Underweight growth stocks, which remain vulnerable to valuation contractions and macro headwinds.
- Overweight value sectors like energy, healthcare, and communications, which trade at discounts of 19%, 17%, and 32%, respectively.
- Hedging with Treasuries: Maintain long-duration bond exposure to capitalize on declining rates, but avoid corporate bonds due to widening credit spreads.

Conclusion: The Correction Is Inevitable

The S&P 500’s rebound has pushed valuations to unsustainable extremes. With the Buffett Indicator at 179.3%, the market is pricing in a 1.7% annualized return over the next eight years—far below historical averages. Add to this a 40–50% recession probability, tariff-related corporate pain, and the Fed’s balancing act between inflation and employment, and the case for caution is overwhelming.

History shows that valuations above 200% (like the late-2024 peak) have always ended in corrections. While the current 179.3% offers a slight reprieve, it remains 65% above its 20-year average. Investors would be wise to lock in gains, reduce exposure to overvalued sectors, and prepare for a prolonged period of low returns—or worse, a sharp decline.

The writing is on the wall: this rebound is overdone. The next move for markets is likely down—investors must position accordingly.