The easiest arrow to land against stocks is that they’re too expensive.

As reported by The Wall Street Journal, the S&P 500 began 2025 with a price-to-earnings (P/E) ratio of 24.7x trailing and 21.4x forward. These figures exceed the averages over the last 5 years (19.6), 10 years (18.1), 15 years (16.4), 20 years (15.8), and 25 years (16.4).

Before turning bearish at the sight of these numbers, it’s worth considering what this rich valuation implies:

• Inflation has improved. While still a concern, it’s forecasted to settle lower.
• The Fed is cutting. Even if only by 50 basis points, short rates are on the decline.
• Recession fears have eased. The U.S. economy appears to have sidestepped the most well-telegraphed recession in history and is not on an imminent path toward one.
• A pro-business administration is heading to D.C. Coupled with expected returns from AI investment, earnings should continue to rise.

In short, the S&P 500’s P/E is high—because it should be.

Valuation reflects and informs us that the story is strong. That’s all—nothing more. Its meaning depends on your perspective.

For long-term investors…

The bar for future upside is high, while the bar for downside is relatively low. Exercise caution and recognize that the winners of 2024 may not repeat their performance in 2025. The Magnificent 7—some of which have gained over 100%—likely pulled forward growth that will be reported, and celebrated, in 2025. Better opportunities may lie among the S&P 493 or in emerging mid-cap names whose growth will benefit from AI investments and didn’t get the benefit of the doubt in 2024.

For short-term traders…

The return of animal spirits creates opportunities for speculative plays on individual names. A more open stance toward M&A and smarter regulation offers a floor for unloved stocks, particularly in regional banks and biopharma. This makes it harder to short these names into oblivion. Just be sure to have strict rules for entry and exit to avoid getting swept up in the excitement.

The risk of a valuation-compression correction is obviously elevated.

Much has gone the way of the bulls; it won’t take much for the bears to reassert themselves in the form of a correction. But for that to happen, some element of the underlying story needs to fall short. Valuation alone won’t be the catalyst. Valuation can’t drive inflation, sway the Fed, strengthen the economy, or dictate the policies of the incoming administration. Valuation is not a causal force, predictive signal, or fortune teller with a crystal ball. It’s the opposite. Inflation, the Fed, the economy, and the administration drive valuation. 

This is the most challenging part of value-investing. The low valuation creates a sense of a higher margin of safety and upside seemingly guaranteed by a “reversion to the mean”. There is a certain allure to the setup. In my opinion, the valuation is low for a reason. Something is wrong with the company, stock, or both. There is no guarantee the valuation will re-rate to the mean unless a fundamental driver proves the valuation incorrect. Low valuation alone won’t cure the stock.

So, if you’re bearish, no problem.

After all, being a permabull is almost an intellectually dishonest as being a permabear. But if you are bearish, it better be because you see a key piece of the story – something priced-in by the valuation – not materializing. Citing the high valuation simply isn’t rigorous enough.