Powell-ignited debate over stock highs… bubble or sustained rally?

Traditional valuation indicators hit record highs

Claims that improved corporate earnings justify high valuations

Some view "higher multiples as the new normal"

Direction may hinge on rate cuts and whether a recession occurs

Jerome Powell, chair of the U.S. central bank, said on the 23rd (local time) that "stocks are quite overvalued," sending ripples through the market. Powell's remarks, combined with doubts about the sustainability of the artificial intelligence (AI) rally, led the Nasdaq Composite to fall 1% on the 24th (local time), the largest one-day drop since August 29.

Powell's comments have especially reignited debate over whether stock prices that have continued to rise are hitting a peak. While some argue various indicators show the market has entered bubble territory, others say a resumption of rate cuts by the U.S. central bank (Fed) could sustain the rally.

Traditional valuation indicators at record highs

According to MarketWatch that day, the CAPE (cyclically adjusted price-to-earnings) ratio devised by Yale professor Robert Shiller has steadily risen during the recent bull market and approached 38 as of the end of August. This is the highest level since the end of 2021. At that time, the market was headed for a major downturn.

Shiller's data are updated monthly, but reflecting the recent upward trend, the CAPE ratio is estimated to have exceeded 40. In fact, Charlie Bilello of Creative Planning wrote this week on X (formerly Twitter) that "the S&P500's CAPE ratio exceeded 40 for the first time since 2000." At that time, a bear market began shortly after the dot-com bubble burst.

The Buffett indicator also suggests that stock prices have recently reached high levels. The Buffett indicator compares the total U.S. stock market capitalization to gross domestic product (GDP). Warren Buffett, chairman of Berkshire Hathaway, said in a 2001 interview with Fortune that "this indicator is the most useful single measure of valuation at a point in time."

According to Dow Jones Market Data analysis, U.S. stock market capitalization was about $64.5 trillion as of the end of June, or 2.7 times GDP ($23.7 trillion in Q2). This is the highest level at least since March 2001. Michael O'Rourke, a strategist at JonesTrading, told MarketWatch that "asset prices are farther ahead of the size of the U.S. economy than at almost any other time in the past."

Upward revisions to U.S. corporate earnings forecasts justify high valuations

The S&P500's 12-month forward price-to-earnings ratio (PER) is about 23.6 times. This means S&P500 stocks are trading at a price equal to 23.6 times the net earnings expected over the next 12 months. Considering the recent 10-year average PER of 18.5 times, prices are still high.

In particular, the Magnificent Seven's weight in the S&P500 has risen to a record high of about 34%, intensifying concentration in a small number of tech stocks.

However, experts say price-to-sales may be a more realistic valuation metric than earnings-based measures. Unlike net earnings, which can vary with accounting treatments, sales are a relatively objective indicator. Corporate value is often assessed using earnings-based metrics like the price-to-earnings ratio (PER). But earnings can be distorted by depreciation and accounting methods, whereas sales are harder to manipulate, so looking at price-to-sales may be more realistic.

The S&P500 companies' forward 12-month price-to-sales ratio is 3.12, the highest since 2000. Yadeni Research also says this metric is at an all-time high.

Yadeni recently noted that corporate earnings forecasts have been revised upward and that corporate profits are likely to hit record highs in the third quarter. While stock prices are high, corporate earnings are also continuing to grow, so these high valuations could be justified.

Savita Subramanian of Bank of America said there is no immediate need to worry about high valuations. She argued that today's large companies differ from firms in the 1980s and 1990s—with lower debt ratios, more predictable borrowing costs, stable results, and automation—so "high multiples themselves could be the new normal." Subramanian said, "Instead of expecting mean reversion to the past, we may need to treat today's valuations as the new benchmark."

With the U.S. central bank (Fed) having resumed rate cuts last week, LPL Financial analyzed on the 24th (local time) that the U.S. stock market, trading near record highs, has a significant chance of rising further.

Adam Turnquist, LPL's chief technical strategist, said, "Since 1984, there have been 28 instances in which the Fed cut rates while the S&P500 was within 3% of its record high," and "in the 12 months following those instances the S&P500 rose an average of 13%, and 93% of the periods produced positive returns."

Whether a recession occurs is crucial

Turnquist tracked S&P500 performance separating cases where a recession coincided with the timing of rate cuts and where it did not. He found that when there was no recession, the average return 12 months later was 18.2%, and all 21 cases produced positive results.

He said, "The current short-term risk of recession is relatively low," expressing an optimistic view. In fact, the U.S. economy grew at an annualized 3.3% in Q2, and the Atlanta Fed's GDPNow also estimates third-quarter growth at a similar level.

Turnquist explained that "Fed rate cuts, the stimulative effects of the 'One Big Beautiful Bill Act,' easing cost pressures and productivity improvements could all support GDP growth."

However, LPL said that when rate cuts coincided with a recession, the market underperformed, with an average return of –2.7% 12 months later and only 25% of periods producing gains. LPL defines a 'cut accompanied by recession' as a recession occurring within six months before or after the rate cut.

New York = Park Shin-young, correspondent nyusos@hankyung.com