A Spot of Bother on the Market

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One really must say, the S&P 500 (^GSPC +0.69%) is behaving rather badly. It’s underperforming the rest of the world – excluding, naturally, the Americans – by a margin not seen since 1995. And the Federal Reserve, bless their cautious hearts, is hinting, rather unsubtly, that valuations are, shall we say, approaching the giddy heights of ‘expensive.’ It’s all terribly tiresome, really.

One feels obliged to point out a few things to the more excitable investors.

The Federal Reserve’s Gentle Rebuke

The chaps at the Federal Reserve don’t, of course, dictate prices. They wouldn’t dream of it. They simply observe that equity prices are, as they put it, “fairly highly valued.” A charming understatement, don’t you think? The minutes from the January meeting were even more forthright, mentioning “high asset valuations and historically low credit spreads.” Apparently, the gap between what one earns on corporate bonds and risk-free Treasury bills is vanishingly small – a mere 71 basis points, if you please. It’s practically giving money away.

This suggests a rather alarming degree of complacency. Everyone is so frightfully confident, much like they were in 1998 with those dot-com things. Now, it’s all artificial intelligence, which, while undoubtedly clever, doesn’t necessarily justify such enthusiasm. The S&P 500 is, undeniably, expensive by historical standards. The staff, with commendable directness, judged that asset valuation pressures were elevated. Price-to-earnings ratios, they note, are at the upper end of their historical distribution.

History, a Most Unpleasant Teacher

Since July 2025, the S&P 500 has been maintaining a forward price-to-earnings ratio above 22. Quite a feat, really. The ten-year average, by contrast, is a mere 18.8 times forward earnings. This level has only been sustained during two periods in the last four decades, both of which, as it happens, ended in rather unpleasant bear markets. Let’s review, shall we?

  • Dot-com bubble: In 1998, the forward P/E ratio exceeded 22, peaking above 24 in 1999. Investors, you see, were piling into technology stocks, many of which were utterly devoid of sustainable business models. By late 2002, the index had fallen 49%. A rather nasty shock, I assure you.
  • COVID-19 pandemic: The forward P/E ratio rocketed to 22, peaking above 23 in 2020. Investors, failing to appreciate the severity of the pandemic, behaved with a distressing lack of common sense. By late 2022, the index had declined 25% as the Federal Reserve, quite rightly, raised interest rates.

What are we to make of all this today? Stocks are historically expensive, credit spreads are tighter than a drum, and a bear market isn’t inevitable, but caution is certainly warranted. If the economic outlook deteriorates and credit spreads widen, companies will have to pay more to borrow money, impacting profits. Earnings would then grow more slowly than Wall Street expects, causing a steep decline in stocks.

One doesn’t suggest selling everything, of course. That would be terribly dramatic. But focusing on high-conviction stocks – those likely to earn significantly more in five years – at reasonable prices is, shall we say, a sensible course of action. It’s a bit like choosing a decent brandy – one must be discerning, you know.

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2026-02-22 11:42