Amid growing speculation about a potential market bubble, Federal Reserve Chair Jerome Powell acknowledged that “by many measures… equity prices are fairly highly valued”. His comments on Tuesday came as multiple key valuation metrics reached levels not seen since the dot-com crash.
Buffett Indicators Flashes Warning Signals
Two of the most closely watched long-term indicators are fueling the debate. The Total Market Cap to GDP ratio, often referred to as the “Buffett Indicator,” has surged to 216.6%, significantly above its historical average, according to data from LongTermTrends.
Valuation Ratios Indicate Stocks Are Overpriced
Simultaneously, the Shiller Cyclically-Adjusted Price-to-Earnings (CAPE) ratio, which measures stock market valuation by averaging earnings over 10 years and adjusting for inflation, has surpassed 40 for the first time since 2000, nearing its all-time high of 44.19 reached in December 1999.
This has prompted analysts to look for historical parallels to the current AI-driven market euphoria, which appears concentrated in a handful of mega-cap stocks.
The forward P/E ratio for the S&P 500 (large-cap) now stands at 22.8, approximately 40% above its long-run average, while mid-cap and small-cap stocks remain near their historical norms.
Analysts Compare Overvaluation To Previous Bubbles
While many analysts compare today's market to the dot-com bubble, some see even greater risks. GQG Research warns that while today's tech giants have stronger balance sheets than the dot-com darlings, the sheer size of the AI boom makes it more dangerous.
“The consequences of the current AI boom could be worse than those of the dotcom era, as its scale—relative to the economy and the market—is far greater,” the firm stated in recent research.
Meanwhile, Wells Fargo Advisors compares the dot-com crash to recent times and notes that in both eras, “a small handful of stocks and sectors carried the S&P 500 to new record highs.” In 2000, information technology and telecom accounted for nearly half the index; today, technology, communications, and consumer discretionary—again dominated by mega-cap tech—make up more than 55%.
Others see darker parallels to an earlier crash. Mark Spitznagel, the founder of Universa Investments and a protégé of “Black Swan” author Nassim Nicholas Taleb, argues that repeated Federal Reserve interventions have created a fragile system.
He warns that by preventing smaller market corrections, the Fed has allowed tinder to build up for a potential “firebomb” worse than anything seen since the Great Depression of 1929.
Powell Sees Overvaluation But Not Yet Alarmed
While speaking in Rhode Island on Tuesday, Powell said, “We do look at overall financial conditions, and we ask ourselves whether our policies are affecting financial conditions in a way that is what we're trying to achieve," according to a CNBC report. He added that “By many measures, for example, equity prices are fairly highly valued."
However, while acknowledging the high valuations, Powell sought to temper immediate fears. He added that he does not believe this is a “time of elevated financial stability risks,” suggesting the central bank is not yet alarmed about systemic threats from asset prices.
Price Action
The SPDR S&P 500 ETF Trust (NYSE:SPY) and Invesco QQQ Trust ETF (NASDAQ:QQQ), which track the S&P 500 index and Nasdaq 100 index, respectively, fell on Tuesday. The SPY was down 0.54% at $663.21, while the QQQ fell 0.66% to $598.20, according to Benzinga Pro data.
On Wednesday, the futures of the Dow Jones, S&P 500, and Nasdaq 100 indices were higher.
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