In December 1996, Alan Greenspan used the phrases “irrational exuberance” to explain the inventory market on the time, and people phrases not solely turned the title of Robert Shiller’s cautionary guide on market bubbles, but in addition the beginnings of the idea that central bankers had the knowledge to be market timers and the ability to bend the financial system to their views. I feel that Greenspan’s phrases appear prophetic, solely with the good thing about hindsight, and I consider that central bankers have neither the ability nor the instruments to maneuver the financial system in important methods. I used to be reminded of that episode after I learn that Jerome Powell, the present Fed chair, had described the market as “pretty extremely valued”. In market technique converse, these are phrases which can be at battle with one another, since markets can both be “pretty valued” or “extremely valued”, however not each, however I do not blame Powell for being evasive. For a lot of this 12 months, and particularly since April, the query that market observers and buyers have confronted is whether or not shares, particularly in america, are pushing into “bubble” territory and headed for a correction. As somebody who buys into the notion that market timing is the inconceivable dream, chances are you’ll discover it shocking that I feel that Powell is proper in his evaluation that shares are richly priced, however that stated, I’ll attempt to clarify why making the leap into concluding that shares are in a bubble, and appearing on that conclusion are way more tough to do.
Monetary Markets in 2025
It has, to place it mildly, been an fascinating 12 months for shares, as financial headwinds and shocks have mounted, with tariffs, wars and politics all including to the combo. After a primary quarter, the place it regarded like monetary markets would succumb to the stress of unhealthy information, inventory markets have come roaring again, shocking market consultants and economists. As a precursor to answering the query of whether or not shares are “pretty extremely valued” at the moment, let’s check out how we bought to the place we’re on September 30, 2025.
Resilient Equities
We are going to begin with US equities, and whereas which will appear parochial, it’s value remembering that they represented greater than 50% of the whole market capitalization of all traded shares on the planet in the beginning of 2025. Within the determine beneath, we take a look at the S&P 500 and the NASDAQ, with the previous standing in as a tough proxy for giant US market cap shares and the latter for know-how corporations:
As you’ll be able to see, US equities have been down within the first quarter, however the standardized values point out that it was a lot worse for know-how corporations than for the remainder of the market, with the NASDAQ down 21.3% by April 8, the market backside, whereas the S&P 500 was down 14.3%. On April 8, the consensus knowledge was that the long-awaited correction was upon us, and that tech shares would take extra of a beating over the remainder of the 12 months. The market, in fact, determined to upend expectations, as tech got here roaring again within the second and third quarters, carrying the market with it. The truth is, by the primary three quarters, the NASDAQ has reclaimed the lead, up 17.3% to date this 12 months, whereas the S&P 500 is up 13.7%.
We take a more in-depth and extra detailed take a look at all publicly traded US equities, within the desk beneath, the place we get away the year-to-date efficiency, by sector:
The 2 finest performing sectors within the first three quarters of 2025 have been know-how (up $3.93 trillion and 22.4% YTD) and communication companies (up $1.29 trillion and 22.3% YTD). There are 5 sectors which lagged the market, with client staples and well being care successfully flat for the 12 months, and power client discretionary and actual property up solely 4-6% for the 12 months. Monetary, industrials and supplies, for essentially the most half, matched the general market when it comes to share change, and the general worth of US equities elevated by $8.3 trillion (13.76%) within the first 9 months of 2025. When you puzzled by the outperformance of communication companies, it’s value noting that Alphabet and Meta, each of which derive giant parts of their revenues from internet marketing, are categorized by S&P as communication service corporations. These two corporations are a part of the Magazine Seven. and the businesses on this grouping have been the engine driving US equities for a lot of the final decade, main to speak of a top-heavy market. To evaluate their contribution to market efficiency, we checked out the mixture market cap of the seven corporations, relative to all 5748 traded US equities in 2023, 2024 and 2025 (YTD):
The mixture market capitalization of the Magazine Seven, as a p.c of market cap of all traded US corporations, has risen from 17.5% on the finish of 2022 to 24.6% on the finish of 2023 to 29.3% on the finish of 2024. Focusing simply on 2025, the Magazine Seven took a step again within the first quarter, dropping to 26.3% of total market cap on March 31, 2025, however has made a decisive comeback since, with a rise in market cap of $2.8 trillion within the first 9 months of 2025, accounting for 52.4% of the general enhance in market capitalization this 12 months. The truth is, the Magazine Seven now command 30.35% of the whole market capitalization for US equities, the next p.c than in the beginning of the 12 months. Over the past three years, the Magazine Seven alone have accounted for greater than half of the rise in market capitalization of all US equities, annually.
There are different dimensions on which you’ll be able to slice and cube US equities, and we did a fast run by a few of them, by breaking US corporations into groupings, primarily based upon traits, and analyzing efficiency in every one:
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Small cap versus Giant cap: For a lot of the massive century, small cap shares (particularly these within the backside decile of market capitalization) delivered larger returns than giant cap shares. As I argued in a publish from a decade in the past, the small cap premium has not simply disappeared for the reason that Nineteen Eighties, however been changed with a big cap premium. returns in 2025, damaged down by market capitalization in the beginning of the 12 months, here’s what we see:
As you’ll be able to see, this has been an excellent 12 months for small cap shares, with the underside half of the market seeing a a lot greater enhance, in p.c phrases, in market cap than the highest half of the market, with a lot of the outperformance coming within the third quarter.
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Worth versus progress: One other enduring discovering from the final century is that low worth to guide shares delivered larger returns, after adjusting for threat, than excessive worth to guide shares. Whereas that is usually categorized as a price impact, it really works provided that you settle for worth to guide as a proxy for worth, however even that impact has largely been absent on this century. Breaking down shares primarily based upon worth to guide ratios in the beginning of 2025, here’s what we get:
Whereas it’s too early to have fun the return of worth, in 2025, low worth to guide shares have carried out higher than excessive worth to guide shares, however the entire outperformance got here within the first quarter of the 12 months.
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Momentum: Momentum has been a stronger drive in markets than both market cap or worth, and in contrast to these two, momentum has not simply maintained its edge, however strengthened it over the previous couple of years. Utilizing the worth change in 2024 as a proxy for momentum, we broke corporations down into deciles and checked out returns in 2025:
After lagging within the first quarter, momentum shares have made a comeback, with the highest half of momentum shares now main the underside half for the 12 months so far in p.c change in market capitalization.
In sum, it has been an excellent 12 months, to date, for US equities, however the positive factors have been inconsistently distributed throughout the market, and whereas the primary quarter represented a break from the momentum and tech pushed market of 2023 and 2024, the second and third quarters noticed a return of these forces.
Directionless Treasuries
Whereas rates of interest are all the time a driver of inventory costs, they’ve performed much less of a task in driving fairness markets in 2025 than in prior years. To see why, check out US treasury charges, throughout maturities, in 2025:
Charges have for essentially the most half are near the place they have been in the beginning of the 12 months, with little or no intra-year volatility however financial tales about inflation and actual progress suggesting greater strikes. The battle between the Trump administration and the Federal Reserve has obtained quite a lot of press consideration, however the Fed’s inaction for a lot of the 12 months and decreasing of the Fed Funds fee in September appear to have had little or no impression on treasury charges.
On Could 16, 2025, Moody’s lowered the rankings for america from Aaa to Aa1, becoming a member of Fitch and S&P, however once more the impact on treasury charges was transient. If you’re questioning why this didn’t translate into a rise in default spreads (and charges), the seemingly reply is that markets weren’t stunned by the downgrade, and the perfect proof for that is within the 5-year US sovereign CDS unfold, a market-set quantity for default threat (spreads):
As you’ll be able to see there was a spike within the US sovereign CDS unfold this 12 months, nevertheless it occurred in response to liberation day on March 31, when President Trump introduced punishing tariffs on the remainder of the world. The Moody’s downgrade had little impression on the unfold, and even the tariff impact had absolutely pale by September 30, 2025, with spreads again to the place they have been in the beginning of the 12 months (and for a lot of the previous couple of years).
Extending the evaluation of default spreads to the company market, there was comparatively little motion in company default spreads in 2025:
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| Supply: FRED |
As you’ll be able to see, essentially the most hanging a part of the story is that so little has modified over the course of 2025, however the spike in spreads within the first week of April, when the tariffs have been introduced. The Moody’s score and the discuss of a recession appear to have carried out little to supercharge the worry issue, and by extension the spreads. The truth is, the one score that has seen a major transfer is within the CCC and beneath grouping, the place spreads at the moment are larger than they have been in the beginning of the 12 months, however nonetheless a lot decrease than they have been on the finish of the primary quarter of 2025.
The Remainder of the Story
The financial shocks that hit the US markets, and which US equities and debt shrugged off, for essentially the most half, additionally reverberated in the remainder of the world. The broadest measure of relative efficiency between US and international equities is the divergence between the S&P 500, a proxy for US fairness efficiency, and the MSCI World index, a stand-in for giant cap worldwide shares, and the outcomes are beneath:
Within the first 9 months of 2025, the MSCI international fairness index is up 16.6%, about 2.3% greater than the S&P 500 over the identical interval. Nevertheless, all of this underperformance occurred within the first quarter of 2025, and the S&P 500 has discovered its profitable methods once more within the second and third quarters.
The MSCI index does obscure variations throughout areas and is titled in the direction of giant cap shares. Consequently, we checked out all publicly traded equities, damaged down by areas, with the values in US {dollars}, and the outcomes to date in 2025 are within the desk beneath:
World equities have been up, in combination greenback market capitalization, by 16.8%, and whereas US equities have underperformed within the first 9 months of 2025, with a 13,8% return, they’ve rediscovered their mojo within the second and third quarters. The worst performing areas of the world are India, down 3.15%, in US greenback phrases, this 12 months, and Africa and the Center East, up solely 2.13%. It’s too early to spin tales for why these areas underperformed, however in my information replace publish from the beginning of 2025, I pointed to India as essentially the most extremely priced market on the planet, and this 12 months could replicate a cleansing up. The remainder of the world ran forward of america, with a few of the extra return coming from a weaker US greenback; the native forex returns in these areas have been decrease than the returns you see within the desk.
US Equities: Overpriced or Underpriced?
Not one of the dialogue above solutions the query that we began this publish with, which is whether or not US equities are overpriced. To make that evaluation, there are a selection of metrics which can be used, and whereas all of them are flawed, they fluctuate when it comes to what they omit of the evaluation, and the assumptions that underlie them.
At one finish of the spectrum, the only and most incomplete metric relies purely on worth historical past, with markets which have had prolonged good runs being considered as overpriced. A modification is to deliver earnings into the evaluation, with costs transferring disproportionately greater than earnings (leading to larger or decrease PE ratios) thought of a sign of market mispricing. The third adaptation permits for the returns you may make on different investments, within the type of rates of interest on treasuries, to make a judgment on market pricing. The ultimate and fullest variant considers progress within the evaluation, bringing in each its good facet (that it will increase earnings in future intervals) and its unhealthy facet (that it wants a portion of earnings to be reinvested), to make a pricing judgment, however even that variant ignores disruptions that alter market dynamics and threat taking.
1. Rising inventory costs
For some buyers, an prolonged stretch of rising inventory costs is, by itself, enough cause to conclude that if shares are doing so effectively, they should be overestimated. This concern will get deeper because the market run will get longer (when it comes to time) and steeper (when it comes to worth rise). Utilizing that framework, you’ll be able to see why discuss of a inventory market bubble has constructed up during the last decade, as shares maintain climbing partitions of fear and hitting new highs. We have had a outstanding bull run in US equities during the last 15 years, with the S&P 500 up over 500% over that interval:
In brief, the annual return (18.74%) that fairness buyers have earned during the last fifteen years is considerably larger than the annual return (9.94%) on US equities during the last century. For some, this run-up alone is sufficient to determine that equities are overpriced and incomplete although this evaluation is, you’ll be able to see its draw for a lot of buyers.
2. The Earnings Impact
rising inventory costs as an indicator of overpricing ignores the truth that markets can generally be up strongly, not due to hypothesis or over pricing, however due to rising earnings. That’s the reason that many buyers take a look at market pricing scaled to earnings, or PE ratios, and the graph beneath captures three variants of the PE ratio – the trailing PE, the place you scale market pricing to earnings within the final twelve months, a normalized PE, the place you scale the market pricing to common earnings over an extended time interval (a decade) and a CAPE or Shiller PE, the place you first modify earnings for inflation after which normalize:
All three variations of the PE ratio inform the identical story, and in September 2025, all three stood near all time highs, with the spike on the peak of the dot com increase being the one exception.
3. The Investing Options
Shares that commerce at larger multiples of earnings are clearly dearer than when then commerce at decrease, however to make a judgment on whether or not they’re overpriced, you continue to have to check them to what you may make on different investments. For buyers in monetary belongings, these different investments are bonds (if you’re investing long run) or industrial paper/treasury payments (if you’re investing quick time period). Logically, if these options are yielding low returns, try to be prepared to pay a a lot larger multiples of earnings for dangerous belongings (like shares). A method during which we are able to deliver on this alternative is by flipping the PE ratio (to get the incomes to cost ratio or earnings yield) and evaluating that incomes yield to the ten-year treasury bond fee:
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Between 2011 and 2020, for example, the earnings yield was 5.46% however that was a lot larger than the 10-year treasury bond fee, which averaged 2.15% over that decade. In 2021, the earnings yield dropped to 4.33%, near a historic low, butt with the treasury bond fee at 1.51%, you would argue that fairness buyers had nowhere else to go. As treasury bond charges climbed again in the direction of 4% in 2022, inventory costs dropped and the earnings yield climbed to five.72%. Within the final three years (2023-25), treasury charges have stayed larger (4% or extra), however earnings yields have dropped. The truth is, the earnings yield of 4% in September 2025 was 0.16% beneath the ten-year treasury bond fee, triggering bearish warnings from analysts who use the distinction between the earnings yield and the ten-year bond fee as their market timing metric.
4. The Remainder of the Story – Money flows, Progress and Threat
The earnings yield, at the side of the treasury bond fee, is extensively used as a market timing software, nevertheless it has two, maybe deadly, flaws.
- The primary is that it treats shares as in the event that they have been glorified bonds, treating the earnings yield like a coupon, and misses the rationale that buyers are drawn to equities, which is the potential for progress. Incorporating progress into the evaluation has two results, with the primary being that you just want reinvestment to develop, and that reinvestment comes out of earnings, and the second being the upside of accelerating earnings over time.
- The second is that the earnings yield/ treasury bond fee differential has had a spotty document timing the market, lacking a lot of the good bull market of the Nineteen Eighties and Nineties, and clearly not offering a lot predictive energy within the final two years.
There may be an strategy that you should use to include the expansion and money stream results into your market evaluation. It’s to estimate an intrinsic worth for the market, the place you incorporate the expansion and reinvestment results into anticipated money flows, and low cost them at a required return that includes what you’ll be able to earn on a riskfree (or near riskfree) funding and a threat premium for investing in equities.
As you’ll be able to see, the intrinsic worth equation can be utilized in one in all two methods to evaluate the market. One is to again out an inner fee of return, i.e., a reduction fee that yields a gift worth equal to the market index; netting out the treasury bond fee from this yields an implied fairness threat premium for the market. The opposite is select an fairness threat premium that you just consider is cheap and to worth the market.
As is commonly the case with historic comparisons, there’s something right here for each facet of the talk. For many who consider that the market is overpriced, the plain comparability is to fairness threat premiums for the reason that 2008 disaster, and the conclusion can be that the Sept 2025 premium of 4.01% is simply too low (and inventory costs are too excessive). For many who are extra sanguine concerning the market, the comparability can be to the dot-com increase days, when the implied fairness threat premium dipped to 2%, to conclude that this market just isn’t in a bubble.
An alternate strategy to assess market pricing is to imagine an fairness threat premium and estimate the worth of the index utilizing that premium. Thus, if we assume that the typical premium (4.25%) from 1960 to 2024 is a good premium to the market, and revalue the index, here’s what we might get as its worth:
With an implied fairness threat premium of 4.25%, and a riskfree fee of 4.16%, we get an anticipated return on shares of 8.41%, and utilizing analyst estimates of progress in earnings and money payout ratios that modify over time to sustainable ranges, we arrive at a price for the index of about 5940, 12.6% decrease than the index worth on September 30, 2025.
The Market Timing Problem
It’s plain that this market is richly priced on each metric, from PE ratios to the earnings yield, web of treasuries, to intrinsic worth measures just like the fairness threat premium, thus offering backing for Powell’s evaluation of equities as “pretty extremely valued”. When you belief in imply reversion to historic averages, it appears affordable to conclude that shares are in reality overpriced, and due for a correction. On this part, we are going to study why, even if you happen to come to this conclusion, it’s tough to transform it into motion.
Utilizing lawyerly language, let’s stipulate that markets are overpriced at the moment, although that overpricing can cowl a spread of views from the market being a bubble to the markets simply being costly. There are 5 responses that you would be able to must this judgment, starting from least aggressive to most aggressive in the marketplace timing entrance:
- Do nothing: The essence of being a non-market timer is that you don’t alter any facet of your portfolio to replicate your market views. Thus, in case your most popular allocation combine is 60% in shares and 40% in your bonds, you stick with that blend, and also you not solely maintain on to your present investments however you proceed so as to add to them in the identical manner that you’ve got all the time carried out.
- Maintain on to/ construct money holdings: For essentially the most half, you match what you’d have carried out within the do nothing response when it comes to total asset allocation combine and holdings, however you not solely put your portfolio additions into money (treasury payments, cash market funds) however whenever you act, it is going to be extra prone to be promoting present holdings (that you just view as over valued) than shopping for new ones. For a lot of fairness mutual fund managers, this statistic (liquid belongings and money as a p.c of belongings underneath administration) is a tough proxy of how bullish or bearish they’re concerning the total market.
- Change asset allocation combine: On this response, you revisit your most popular asset allocation combine, which was set primarily based in your age, money wants and threat aversion, and alter it to replicate your market timing views. Thus, if you happen to consider that shares are overpriced, however you view bonds as pretty and even underneath priced, you’ll lower your allocation to the previous, and enhance your allocation to the latter. If you’re constrained to be an all-equity investor, an alternate model will probably be to reallocate your cash from overpriced geographies to underpriced geographies, if the latter exist.
- Purchase safety: With the expansion of choices and futures markets, you now have methods of defending your portfolio, with out making wrenching modifications to your asset allocation or holdings combine. You should purchase places on the index or promote index futures, if you happen to assume equities are overpriced, and profit from the truth that the earnings from these positions will offset the losses in your portfolio, if there’s a correction.
- Make leveraged bets of market correction: Probably the most aggressive strategy to benefit from market timing is to make leveraged bets on market corrections, utilizing both derivatives markets (places or futures) or promoting quick on both the entire shares in an index, or a subset of essentially the most overpriced.
In making this decisions, you do have to think about three actual world issues. The primary is taxes, with any methods that requires important disruptions to present portfolios, comparable to altering asset allocation mixes or promoting overvalued shares within the portfolio, creating bigger tax payments. The second is transactions prices, which will even be larger for any technique that’s constructed round extra aggressive. The third is timing, which is that even if you’re proper concerning the overpricing, being proper too early could wipe out the advantages. Talking of Alan Greenspan’s warnings concerning the dot com bubble, it’s value remembering that his “irrational exuberance” feedback have been made in 1996, and that the market correction occurred in 2001, and any investor who offered equities proper after the feedback have been made would have underperformed an investor who held on to equities and took the hit from the correction.
Let’s assume that you just take away taxes and transactions prices from the evaluation to offer market timing the absolute best pathway to success. To check whether or not market timing works, it’s important to create a market timing technique round your metric of alternative, with three steps fleshed out:
- Select your pricing metric: As famous within the final part, this may be the share enhance in inventory costs over a current interval, the present or normalized pricing ratio (PE, PBV, EV to EBITDA) or the fairness threat premium/intrinsic worth for the index.
- Create your motion rule: The motion rule specifies the brink for the chosen metric, the place you’ll act in your market timing. You possibly can, for example, determine that you’ll enhance your fairness publicity if the PE ratio is greater than 25% beneath the median worth for the market’s PE ratios over the earlier 25, 50 or 100 years, and scale back your fairness publicity if the PE ratio is greater than 25% larger than the median worth over the interval. Word that the commerce off on setting the brink is that setting it to a bigger worth (say 50%) will imply that you just time the market much less.
- Select your market timing response: You specify how a lot you’ll enhance or lower your fairness publicity in response to the market timing sign. Thus, you probably have base asset allocation mixture of 60% equities, 40% bonds, you’ll be able to determine that in case your threshold (from step 2) is breached, and the PE ratio drops (will increase) by greater than 25% beneath the median, your fairness publicity will enhance (lower) to 80% (40%) and your bond publicity diminished (elevated) to twenty% (60%). The extra aggressive you’re as a market timer, the higher would be the shift away out of your base combine. Thus, you would promote all equities (0% equities, 100% bonds) if the market is overpriced and maintain solely equities (100% equities, 0% bonds) if the market is underpriced.
As an example, let’s use the Shiller PE, choose a 25% threshold for market cheapness and alter your asset allocation combine, which might usually be 60% fairness/40% debt to 80% equities/20% debt if the Shiller PE drops 25% beneath the median (computed over the prior 50 years) and 40% equities/ 60% bonds if it rises 25% above the median.
Word that the take a look at can simply be diverse, utilizing a special metric, completely different thresholds and completely different timing responses.
To keep away from being accused of cherry selecting the information or deviating from the usual measures of the Shiller PE, I downloaded the uncooked information on inventory returns, bonds and the CAPE annually from 1871-2025 from Shiller’s personal webpage. To compute the payoff to market timing, I regarded on the annual returns to an non-market-timing investor who stayed with a 60% fairness/40% bond combine over time and in contrast it to the returns of a market timer, utilizing the brink/motion technique described above:
Over the past century, this market timing technique would have diminished your annual returns 0.04% annually, and that’s earlier than transactions prices and taxes. When you break this up into two half-centuries, any of the market timing positive factors have been from 1924-1974, and so they have been gentle, and making an attempt to time the market would have diminished your annual returns by 0.41% a 12 months, on common between 1975 and 2024.
To judge whether or not the payoff would have been completely different with alternate thresholds, we thought of each a a lot decrease threshold (10%) and a a lot larger one (50%), with the previous resulting in extra market timing actions. We additionally checked out a extra aggressive response, the place the fairness portion was elevated to 100% (as an alternative of 80%) if the market was underpriced and diminished to 0% (as an alternative of 40%) if the market was overpriced. The outcomes are in beneath:
Conclusion
The choice on whether or not to time markets is a private one, and whereas I’ve concluded it doesn’t work for me, it will be presumptuous to assert that it’ll not be just right for you. When you determine that market timing is a part of your funding philosophy, although, there are three classes that I hope that this publish has highlighted. The primary is that the extra incomplete your market timing metrics are, the higher the possibility that you’ll chasing a correction that by no means occurs. It’s the cause that try to be skeptical about arguments constructed round simply pricing, PE ratios or earnings yields (relative to treasury bond charges), and even with extra full metrics, try to be scanning the horizon for elementary modifications within the financial system and markets which will clarify the deviation. The second is that the proof {that a} metric will be just right for you is not going to come from statistical measures (correlations and regressions), however from creating and back-testing an actionable technique (of shopping for or promoting traded devices) primarily based on the metric. The third is that even if you happen to do all of this due diligence, market timing is noisy and flawed, and paraphrasing one other extensively used expressions, markets can keep mispriced for longer than you’ll be able to keep solvent.
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Datasets
- Historic returns on shares, bonds, payments, actual property and gold: 1927 – 2024
- PE, Normalized PE, Shiller PE and Earnings Yield Information for US Shares: 1960-2025
- Shiller information on inventory returns, rates of interest and CAPE (month-to-month): 1871-2024 (from Shiller)
- Implied Fairness Threat Premiums for the S&P 500: 1960-2025
Spreadsheets