Make no mistake: Stocks are expensive, with the companies in the S&P 500-index currently at 28 times trailing 12-month reported earnings, offering a dividend yield of just 1.3% and sporting a Shiller price-earnings ratio of 37. All three metrics suggest stocks are pricey by historical standards.
Meanwhile, with far less risk, investors can collect 4.5% in annual interest with 10-year Treasury notes and an inflation-adjusted 2.1% with 10-year inflation-indexed Treasurys. Alternatively, for those who favor cash investments, there’s Vanguard Federal Money Market Fund (symbol: VMFXX), with its 4.2% yield.
With stiff competition from conservative investments, and with all the talk of slower economic growth, you’d imagine that stocks would trade at lower valuations—or, at least, that would be my guess. So why are valuations so rich? Three possibilities:
- Investors are anticipating that corporate earnings will soar. Perhaps investors are, but S&P Global sure isn’t. The research firm behind the S&P 500 is forecasting as-reported earnings will climb 15% in 2025 and another 15% in 2026—healthy gains, but hardly the stuff of irrational exuberance.
- We’ve moved into an era where stocks have been repriced to permanently higher valuation levels. This might reflect the high growth rate of today’s mega-cap U.S. stocks, notably technology shares. Alternatively, it may be that investors are simply much more comfortable holding stocks than they were three or four decades ago. I say all this with trepidation given the infamous remark made by economist Irving Fisher just before the 1929 stock-market crash: “Stock prices have reached what looks like a permanently high plateau.”
- The valuation yardsticks we’re using don’t capture how valuable today’s companies are. For instance, because companies are using so much of their spare cash to buy back shares, they’re less focused on paying dividends, so it’s hardly surprising dividend yields are low by historical standards. Similarly, because today’s high-growth companies are rich in intellectual capital, they look far less appealing when their share prices are compared to traditional measures of corporate assets.
None of this is prompting me to make any portfolio changes. I long ago concluded that valuation measures were no predictor of short-term stock-market movements, and that my best bet was to buy, hold and look to the long term. Still, if the economy slowed sharply, I imagine today’s rich valuations mean share prices could suffer a steep decline.
Thanks for the thought exercise Jonathon. IMO, Ignoring valuations would be to your portfolio like what ignoring your health would be to your duration & quality of life. In that context, the question really answers itself…
I’ve been “mostly” retired for 3 years now and plan to fully retire in a few more months. I’m a mostly defensive, buy & hold value & dividend yield investor with a heavy concentration in hard assets (infrastructure, commodities – ie energy & PM’s, and REITs/ R.E. News flash: most REITS are not historically expensive, valuation-wise, right now. In fact many high quality names (like ARE, AHH) are at historically exceptional discounts to their NAV’s.
I also like hi yielding preferred shares purchased below call value in certain very stable/ strong Mtg & Equity REITs, and investing in moderation in BDCs, CEFs, MLPs and even some CLO via ETFs.).. I only own one “Mag-7” stock (APPL), which I’ve held for over a decade, and I’ve never owned bitcoin, so I mostly missed the Covid explosion valuations of all the big tech/ high growth names. “Oh well !”
OTOH when the S&P plummeted for a few weeks > 4/2/25 my max portfolio drawdown before the subsequent (rapid) recovery was < 8%, when my relatives & friends who love AI and the big tech names were all pretty crestfallen. My portfolio value is now higher than it was on 4/1, despite net withdrawls since then for mortgage payments, home improvements, etc.
And, the high dividend yield aspect of my investing style reduces volatility quite a bit, and makes me fairly sanguine/ resilient whenever my portfolio does experience volatility. I suspect there’ll be much more volatility ahead for us all over the next few years…and disappointing 10-year returns from here especially for S&P 500 investors, for the reasons you described re: current valuations which are very high based on the Buffet yardstick and many other historical valuation measures.
I have a tax background so I’m careful to hold investments where those high dividends & MLP distributions yield are almost all tax deferred or tax free (w/ no UBTI). Quite a few K-1’s on our tax return, but like anything else – knowledge is acquirable and even complex topics are manageable…the fear of the task is typically much worse than the reality. Holding MLP’s in taxable brokerage accts is a very powerful retirement savings accumulation tool, IMO.
Sorry this went so long, but I wanted to explain why I’m not too worried about valuations at the moment, even though I completely agree that wide areas of the market (ie the S&P500, Nasdaq, & growth stocks generally) are probably overdue for a major drawdown when the next “risk off” wave arrives… perhaps triggered by a US recession, or maybe due to various other negative geopolitical/ macro factors that always seem to be on the horizon lately. Tariff’s, inflation, higher 10-30 Yr interest rates? (Etc!.)
So, I’m personally not overly “worried” about valuations today, per se, based on how I’ve positioned our portfolio ever since Covid. But I will never ignore valuations. in fact when the big drawdown finally does arrive, I plan to focus on valuations intently – to rebalance much of our current holdings allocations away from short term treasuries, money market funds & high yielding preferred shares, and into newly beaten-down equities that I view as too expensive to buy today, but which may then become too attractive valuation and/or yield-wise to ignore.
Stock valuations are high because they’ve been artificially boosted by the massive increase of the money supply by the Federal Reserve. This was started during the 2008 finical crisis and expanded during the pandemic.
buddy mine was in big/short bonds in the days of local banking…’a corp want to park 100 million bucks for a week, how can i squeeze parts of a basis point??’
he’d do work between banking hours in the morning–done early. plenty of time to think.
his observation was ‘money has to go somewhere…’..and i asked where and said ‘it varies…’