It is certainly true that company valuations are somewhat elevated by comparison to their long-term levels. That is not in dispute. The key question is whether it matters, or indeed has any salience whatsoever when it comes to one’s investment decisions. On both those counts, we say no.
Revenues and rate cuts
Firstly, we note that the run-up in stock market prices is not entirely without basis. In the most recent reporting season, US company earnings were up 12% compared to the year before. And likewise, 2024’s results suggested that firms were in robust health. Plus, with the dollar’s weakness, it’s now more profitable for US companies making earnings abroad.
Lately, market gains have been driven in part by the Federal Reserve cutting interest rates. Lower rates boost asset prices – although this is a bit like going downhill on a hilly hike: it’s easier for a time, but you have given up some “potential energy”. Such gains should be distinguished from boosts to share prices due to either better earnings prospects or more exuberant sentiment.
Valuation inflation?
But more importantly, we would argue that valuations are entirely backward-looking measures. When one says that “valuations are expensive”, the question has to be, compared to what? The long-run average company valuation has been steadily increasing for many years now – why should it “revert” to some now-irrelevant historical average?
Supply and demand for financial assets matters considerably, and there has been a wall of money flowing into stocks and shares ever since the democratisation of investing thanks to index funds and low-cost platforms. American 401K plans have funnelled plentiful wealth into listed assets. Is it any wonder that valuations now look “pricey” compared to a world before financial technology made mass retail investment so easy?
Causality
Moreover, valuations offer no causal explanation of share price movements. There has never been a stock market crash precipitated by high valuations, as if “overdue”. It has always happened for a sensible reason. Of course, when share prices fall – whatever the trigger – it is inevitably the case that we find the highest valuations just before the drop… but this is to argue that tyre skid marks cause car accidents.
Share prices fell 10% in two days back in April, as markets digested President Trump’s tariffs – so it is difficult to argue that investors are in a perpetual state of euphoria. Instead, the consensus seems to be that, although the US economy is still digesting the after-effects of pandemic policies, and the employment picture is extremely murky, there is nothing concrete to fear. On the other hand, escalating revenues from AI are very real.
On all-time highs
Markets have to look ahead to assess the future value of new technologies, and it could of course be the case that the collective wisdom is too optimistic – or perhaps too pessimistic. We simply cannot know.
But we can however observe that hitting regular all-time highs is par for the course for stock markets. They do not augur a reckoning. In fact, we don’t think they augur anything.