The Everything Valuation: Are Markets Pricing in a Perfect World?

There's a thought experiment I find useful when trying to assess market conditions: what would prices look like if we were in the best possible version of the current world? Strong growth, falling inflation, AI productivity boom, soft landing achieved, earnings delivering, geopolitical risks contained. What would the S&P 500 trade at in that world?

The answer, increasingly, is: about where it is now. And that should give us pause.

The valuation picture

US equity markets are expensive by almost every traditional measure. The Shiller CAPE ratio — which smooths earnings over 10 years to control for cyclical variation — is above 35x. The last time it was consistently this high was the late 1990s tech bubble. The forward P/E on the S&P 500 sits above 21x, pricing in robust earnings growth that has to materialize to justify current levels.

The counterargument is familiar: rates were higher in the 90s, the composition of the index is different now, mega-cap tech is genuinely different from the speculation of the dot-com era, AI represents a real productivity wave. These arguments aren't wrong. They're just not reliably predictive.

High starting valuations don't tell you when a correction will happen. They're one of the few variables that do have a meaningful, documented relationship with long-run forward returns. If you're investing with a 10+ year horizon, starting valuation matters. If you're trading the next six months, it's essentially noise.

The concentration problem

The S&P 500 is more concentrated than at any point in its history. The top 10 companies account for roughly 35% of the index's market capitalization. Five companies — Microsoft, Apple, Nvidia, Alphabet, Amazon — are each worth more than most countries' entire stock markets.

This creates a peculiar situation where "diversified" index investors are substantially exposed to a handful of companies' fortunes. It also means that the valuations of those specific companies drive the index's overall valuation in ways that can be misleading. The median stock in the S&P 500 is considerably cheaper than the market-cap weighted average suggests.

The AI premium

Nvidia's valuation deserves its own paragraph because it illustrates something important about how markets are pricing AI. At peak, Nvidia traded at a P/E ratio that implied extraordinary growth for an extended period — well above what even its extraordinary recent growth rates could sustain indefinitely. The market was pricing in the company's role as the essential infrastructure provider for an AI buildout that may or may not proceed at the implied pace.

This is not irrational. If AI buildout continues at current rates for five to ten years, the implied valuation might look cheap in retrospect. It's a bet on a scenario, and it's a plausible scenario. It's just priced as close to certainty as a volatile growth stock can be.

The thing to watch

Credit markets are the part of this picture I find most useful to monitor. When credit spreads widen — when the cost of borrowing for lower-quality companies increases relative to safe assets — it's usually a signal that the financial system is pricing in more stress than equity markets acknowledge. Right now, credit spreads are tight. That's consistent with the "soft landing achieved" equity narrative. If that changes, watch equities.

None of this is a prediction. Markets can stay expensive for longer than seems reasonable. They can also correct quickly and for reasons that weren't the ones everyone was watching. What I'd push back on is the idea that current valuations are "new normal" rather than "historically elevated." The data says elevated. What happens next is genuinely uncertain.