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At first glance, the current stock market seems contradictory. On the one hand, many indices are trading close to or at all-time highs, but on the other, there is no feeling of widespread euphoria. There is no widespread speculation, no classic "everything is rising" phase. Instead, we are seeing a market that is expensive, but at the same time selective, more rational than previous high phases and strongly characterized by expected values.
If you start with the naked valuation, the picture is clear. The US equity market, represented by the $CSPX (-0,23%) (S&P 500), is clearly trading above its long-term norms. The forward P/E ratio of the index is currently around 21 to 22, while the 10-year average is closer to 18 to 19. This corresponds to a valuation premium of around 10 to 15 percent. However, this figure alone is only of limited significance, as it is heavily dependent on the current earnings situation and the respective estimates.
It is therefore worth looking at long-term smoothed valuation measures, above all the Shiller CAPE. This ratio compares the current index level with the inflation-adjusted average of corporate profits over the past ten years. The aim is to smooth out cyclical exaggerations in individual years and obtain a more stable picture of the structural valuation.
The Shiller CAPE of the S&P 500 is currently in the range of around 38 to 40. The long-term median is around 16, the long-term average around 17. This means that the market is trading at more than twice the level of a historically normal valuation situation. Comparable levels have only been reached in a few phases in the past, such as at the turn of the millennium or in individual exceptional situations thereafter.
A regional comparison helps to classify this figure. Japan is currently trading at a CAPE of roughly 28, while Europe is more in the region of around 20, which means that these markets are not cheap either, but are valued much less ambitiously than the USA. This underlines the fact that the high valuation level is not a global phenomenon, but is strongly US-centric - and is in turn particularly characterized by a few heavyweights.
The correct interpretation of this signal is crucial. The Shiller CAPE is not a timing instrument. It says nothing about when a market will fall or rise. Its strength lies exclusively in the classification of the long-term expected value. Historically, it has been shown that the higher the CAPE at the time of entry, the lower the average returns over the following seven to ten years. High CAPE values did not necessarily lead to losses, but almost always to below-average results compared to more favorable entry phases.
Today's market fits exactly into this pattern. The high CAPE does not signal an imminent correction, but an environment in which future earnings must come more from profit growth, cash flows and distributions. The scope for further multiple expansion is limited. The market demands substance.
A second long-term valuation framework is the so-called Buffett indicator. It puts the total market capitalization of a stock market in relation to economic output, usually measured by gross domestic product. The basic idea behind this is simple: in the long term, corporate profits cannot grow faster than the underlying economy. If market capitalization diverges too far from GDP, the demands on future profits and returns on capital increase considerably.
For the USA, this indicator is currently over 200%. Historically, the long-term average has tended to be in the range of 70 to 100 percent. Again, this is not a short-term warning signal, but a structural one. Such a high value means that the market is making very optimistic assumptions about margins, returns on capital and earnings growth.
These assumptions have not been plucked out of the air. Two factors explain a large part of today's valuation levels: firstly, an interest rate environment that continues to imply low long-term real yields despite monetary policy tightening, and secondly, unusually high margin stability of large companies. Dominant platform models, high barriers to market entry and economies of scale ensure that many heavyweights consistently achieve higher operating margins than previous market generations. This justifies higher multiples - at least as long as these margins can be defended.
The Buffett indicator becomes particularly revealing when the concentration effect is taken into account - analogous to the forward P/E ratio and CAPE. The so-called "Mag 7" now make up around 30 to 32 percent of the total market capitalization of the S&P 500, but account for an even larger share of aggregated profits. If this group is approximately excluded from the Buffett indicator, the ratio of market capitalization to GDP is significantly reduced. Instead of a value of over 200 percent, the adjusted indicator would be roughly in the range of around 140 to 160 percent.
This value is also historically high, but is in a completely different order of magnitude. It does not signal a structural extreme, but an ambitious but explainable valuation. The extreme character of the aggregated Buffett indicator is therefore - just as with the Shiller CAPE - to a large extent a concentration phenomenon.
If this observation is combined with the other indicators, a consistent picture emerges. The forward P/E ratio of the $SPX is currently around 21 to 22, without the "Mag 7" it would be around 16 to 17 and therefore close to the long-term average. The Shiller CAPE is falling from around 38 to 40 to around 26 to 28 and the Buffett indicator is falling from over 200% to a historically high, but not extreme, level. Three different valuation approaches, constructed independently of each other, thus come to the same conclusion: the perceived overvaluation of the market as a whole is largely the result of a strong concentration on a few, highly valued heavyweights.
A look beyond the USA reinforces this impression. The global equity market, as represented by the $IWDA (+0,03%) (MSCI World), is also trading above its historical averages, but to a lesser extent. Europe remains more moderately valued in comparison, which is reflected not only in the lower P/E ratio, but also in the lower CAPE.
What does this mean for the return outlook? Historical CAPE regressions provide at least a rough guide here. At a CAPE level of around 38 to 40, the average annual returns of the US market in the following ten years were typically in the range of around 2 to 4 percent. This is not an exact forecast value, but a corridor of expectations. It does not necessarily imply poor results, but significantly lower returns than in phases of low valuation. Markets with CAPE values of around 20, such as Europe, have historically tended to be in a range of around 4 to 6 percent.
Putting valuation, market phase and capital flows together, a clear picture emerges. The market is no longer in a build-up phase in which bad news is ignored. However, it is also not in a classic euphoria phase. It is a mature acceleration phase. Profits are available, capital is invested, but it is flowing selectively. Mistakes are being punished again, quality is being paid for, hope without cash flow is increasingly being questioned.
The consequence of this is a shift in the source of returns. The past few years have been strongly characterized by multiple expansion. At today's valuation level, returns come primarily from earnings growth, cash flow and dividends. This explains why business models with strong cash flows are still in demand, while insubstantial story stocks are becoming less attractive.
Perhaps this is the real insight of this market environment: it is not the market that is the problem, but the expectation of it. Those who expect the same returns today as in the past decade will inevitably be disappointed. On the other hand, those who accept that the market has become more mature, more selective and more demanding will continue to find approaches that work. Not everywhere. Not automatically. But where price, expectation and substance fit together again. This is precisely why it is currently less about market opinions - and more about clean decisions.
