Are Markets Expensive Right Now?

It’s 3:45 PM, and you’re checking your portfolio. You’ve been nervous for weeks. You’re not sure if it's time to take some profits or add more positions, but one thing is gnawing at you: are markets overvalued? You see a sea of green in tech stocks, and mainstream media keeps pushing the idea that this is the new normal. But what if it isn’t?

The truth is, whether markets are expensive or not depends on how you define "expensive." Traditionally, it’s measured through ratios like the P/E (Price-to-Earnings) ratio, CAPE (Cyclically Adjusted Price Earnings), or the Price-to-Book ratio. Let’s break it down.

1. The Price-to-Earnings (P/E) Ratio Historically, the P/E ratio for the S&P 500 hovers around 15-16x earnings. Right now, it’s sitting closer to 25x earnings. That’s almost 50% higher than the historical average. To put that into perspective, in 2000, right before the dot-com bubble burst, the P/E ratio was around 30. Does that mean we’re headed for another crash? Maybe. But P/E ratios don’t tell the whole story. After all, earnings themselves have increased due to technological innovations and globalization, meaning a higher ratio could simply reflect the increased profitability of companies today compared to two decades ago.

2. The CAPE Ratio The CAPE ratio is another popular valuation tool, which adjusts for inflation and looks at earnings over a 10-year period rather than the typical one year for P/E. The current CAPE ratio is over 30, which is well above its historical average of around 16. The only times the CAPE ratio has been this high were before major market corrections, including the 1929 crash and the dot-com bust. But again, the landscape has changed, so while this could be a red flag, it doesn’t guarantee a downturn.

3. The Price-to-Book (P/B) Ratio Another metric to consider is the Price-to-Book ratio, which compares a company’s market value to its book value (what it would be worth if it were liquidated). For the S&P 500, this is currently around 4x, which is higher than historical averages of around 2-3x. This suggests that investors are paying a premium for assets, which could indicate overvaluation.

But here’s where things get interesting: markets are only as expensive as people are willing to pay. Behavioral economics shows us that sentiment often drives prices just as much as fundamentals. Investors are riding a wave of confidence due to low interest rates, central bank interventions, and strong earnings from tech giants. The market could continue its climb, even if traditional metrics scream “overpriced.”

4. Low Interest Rates Are Fueling High Valuations Central banks around the world have kept interest rates low for years, making borrowing cheaper for companies and consumers alike. This leads to more money being pumped into the economy, and a lot of that money finds its way into the stock market. When interest rates are low, future earnings are worth more in today’s dollars, which justifies higher stock prices.

Let’s put it another way: in 1980, the U.S. Federal Reserve’s interest rate was 19.1%. Today, it’s hovering near 0%. At that time, a 10% P/E ratio was considered reasonable because bond yields offered significant competition for investor dollars. Now, with bonds offering next to nothing in returns, investors are willing to pay more for equities, pushing up P/E ratios. So, while traditional valuation metrics might suggest markets are expensive, the current low-interest-rate environment may actually justify these higher valuations.

5. Inflation Could Be a Game-Changer Inflation is another key factor to consider. If inflation starts to rise significantly, it could erode the purchasing power of future earnings. Right now, inflation is running hotter than it has in decades, with the U.S. Consumer Price Index (CPI) showing annual increases of over 5%. The Federal Reserve maintains that this is “transitory,” but if they’re wrong, we could see higher interest rates, which would lead to lower valuations.

So, Are Markets Expensive? Here’s the kicker: even though valuations are stretched, that doesn’t mean they’ll crash tomorrow. Bull markets don’t die of old age—they’re killed by external shocks. Think pandemics, wars, or financial crises. Without a catalyst, high valuations can persist for a long time. Just look at Japan, where the Nikkei 225 reached a P/E ratio of over 70 during the late 1980s before crashing spectacularly.

For the average investor, the real question is: what’s your time horizon? If you’re investing for the next 30 years, short-term volatility doesn’t matter much. On the other hand, if you need access to your money in the next five years, you might want to reconsider your risk tolerance. Regardless, markets are certainly not cheap right now, and being cautious is warranted. But don’t confuse “expensive” with “doomed to collapse.” The economy is evolving, and so are market valuations.

Conclusion The concept of market valuation has evolved. Traditional metrics like P/E, CAPE, and P/B ratios suggest markets are expensive, but factors like low interest rates and technological advancements challenge those conclusions. Meanwhile, inflation and potential external shocks add complexity to the forecast. While high valuations don’t necessarily signal an imminent crash, they do indicate that caution and a long-term perspective are prudent. Whether markets are expensive for you comes down to your personal financial goals and risk tolerance.