Stocks Are Historically Pricey: While Some Analysts Suggest This Is "the New Normal," It's Not as Cut-and-Dried As You Think
News Summary
Some Wall Street analysts, including Savita Subramanian of Bank of America, suggest that high stock valuations represent a "new normal," citing rapid artificial intelligence (AI) growth and resilient earnings from influential businesses. They argue investors should anchor to today's multiples rather than expecting mean reversion to a bygone era. However, the article contends that while a "new normal" for valuations has existed since the mid-1990s due to internet proliferation and lower interest rates (shifting the Shiller P/E from 10-20 to 20-30), current valuations far exceed this. The market is currently the second-priciest in 154 years, with the Shiller P/E peaking at 40.15, nearing dot-com bubble highs. Historical data reveals that every one of the six instances where the Shiller P/E surpassed 30 has eventually led to significant declines in major indexes, ranging from 20% to 89%. The article warns that while stocks can remain pricey for years, history is clear that extended periods above a 30 multiple are unsustainable and eventually met with significant selling pressure. The author suggests investors consistently overestimate early adoption and utility of game-changing technologies, implying AI could be in a bubble, and advises against anchoring to current high valuations.
Background
The broad-based S&P 500, iconic Dow Jones Industrial Average, and growth stock-dominated Nasdaq Composite have been unstoppable for the better part of the last 16 years since the Great Recession ended. Despite heightened volatility in late March and early April, all three indexes have blasted to multiple record-closing highs in 2025. Catalysts fueling this rally include the evolution of artificial intelligence (AI), an expectation that the Federal Reserve will continue to cut interest rates, and a forthcoming resolution to tariff-related uncertainty. As stocks have risen, so have valuations. By one measure, the Shiller price-to-earnings (P/E) Ratio, the market is currently the second-priciest in 154 years.
In-Depth AI Insights
Does Wall Street's "new normal" valuation argument mask deeper underlying risks? - Wall Street analysts, particularly from firms like Bank of America, justifying high valuations with AI growth and corporate earnings might be seeking to support short-term market sentiment rather than adhering to long-term historical patterns. This narrative could lead investors to disregard the lessons of historical valuation cycles, where excessive optimism often signals a bubble. - While information accessibility and lower interest rates since the internet era have indeed redefined "normal" valuation ranges, the current Shiller P/E exceeding 40 is well beyond even this new "normal" upper bound. This suggests the market might be in a speculative frenzy phase, rather than merely a fundamental re-rating. Given the context of the Trump administration's policies and expectations for rate cuts, what additional complexities does this historical valuation warning present? - President Trump's re-elected administration is generally perceived as pro-business and potentially supportive of deregulation, which could provide psychological support to the market in the short term and potentially boost corporate earnings expectations through fiscal stimulus or tax cuts. This outlook might temporarily overshadow concerns about high valuations. - However, expectations of Federal Reserve rate cuts, if driven by political pressure or misjudgment of inflation rather than genuine economic weakness, could exacerbate asset bubbles in the long run. While resolution of tariff uncertainty is a short-term positive, if fundamental global trade friction issues remain unaddressed, the market could still face new shocks. For long-term investors, what strategic asset allocation and risk management measures should be considered in this environment of "historically pricey but potentially sustained" valuations? - Investors should be wary of over-exuberance for "the next big thing," especially in technological areas like AI that have yet to widely optimize for profitability. History shows that disruptive technologies often undergo bubble bursts in their early stages, so caution is advised for highly valued growth stocks, including the "Magnificent Seven," scrutinizing their earnings quality and actual return on investment. - Consider rotating capital from highly valued, high-risk growth stocks towards sectors with stable cash flows, reasonable valuations, and defensive characteristics. Diversify into uncorrelated assets, such as high-quality bonds or gold, to hedge against potential market corrections. - Adopt a more disciplined investment approach, such as dollar-cost averaging, and re-evaluate portfolio risk tolerance to prepare for potential significant market adjustments rather than blindly chasing short-term momentum.