What could go right and wrong for investors
Pullbacks within a secular bull market are inevitable. Since 1950, we’ve seen a market decline of 20% or more once every 5 years, on average, and a drop of 15% or more once every 3 years, on average. Looking ahead, pullbacks within the current secular bull could be driven by big-picture concerns that include policy uncertainty, geopolitical turmoil, and potential growth challenges.
However, one major ongoing worry—the direction of policy interest rates—could swing in favor of stock investors. US Federal Reserve Chair Jerome Powell’s speech in Jackson Hole, Wyoming, in late August signaled the potential for lower rates ahead. The Fed initiated a 25-basis-point rate cut in September and signaled the potential for additional cuts into 2026, if needed. We believe that lower rates could support stock markets and a steeper yield curve.
As for valuations, the S&P 500 is indeed historically expensive. Near the end of August, it traded at 22x forward earnings (meaning, price divided by estimated earnings for the next 12 months), compared with an average of 17x over the past 30 years.
Is this historical average a fair comparison? Perhaps not. Financials and energy are now a smaller part of the S&P 500 than they had been, on average, over the past 3 decades. Each has tended to trade at lower-than-average valuations over this time frame. Conversely, information technology composes a larger percentage of the S&P 500 (34%) than it had over the past 30 years. Technology trades at a premium because of its above-average growth rates.
We believe valuation concerns could be largely extinguished with better-than-expected earnings over the next 12 months, driven by factors including stronger-than-anticipated technology adoption, including artificial intelligence. This could help organically reduce earnings multiples.