Are US Equities in a Bubble? Or Just Priced for a Different World?

Whenever the S&P 500 posts new highs on rich multiples, talk of ‘bubbles’ resurfaces. The Shiller CAPE is, as of August 2025, elevated versus much of the post-war period, and forward price–earnings ratios sit above their longer-run averages. But ‘high’ is not the same as ‘irrational’. A large share of valuation variation over time reflects movements in discount rates and required returns, not just changing growth prospects (Cochrane 2011; Campbell and Shiller 1998). Structural shifts also matter: an economy heavier in intangibles, changes in accounting, curated index construction, and lower frictions to investing can all sustain higher equilibrium valuations than in earlier decades, even as they imply lower long-run returns from today’s starting point (Lev and Gu 2016; S&P Dow Jones Indices 2024).

What Counts as a ‘Bubble’?

By ‘bubble’ most observers mean prices far above fundamentals, driven mainly by extrapolative beliefs rather than cash-flow or discount-rate logic (Baker and Wurgler 2007). That is a higher bar than simply noting that multiples are above their historical mean. Valuation ratios have always been time-varying; the harder question is why. If today’s pricing can be understood by lower perceived macro uncertainty, different real-rate regimes, and changes in the underlying businesses being valued, ‘expensive’ need not equal ‘bubble’ (Cochrane 2011; Greenwood and Shleifer 2014).

Discount Rates, Inflation and Fair Value

Valuation is just discounted cash flow. When the real risk-free rate and/or the required equity premium fall, fair prices rise. Conversely, a rising real yield/ a higher required equity premium will cause fair prices to fall. A substantial literature attributes much of the movement in aggregate valuations to shifts in the required return rather than to revisions in long-run cash-flow growth (Cochrane 2011; Campbell and Thompson 2008). That helps explain why the low-inflation, low-interest-rate environment of the 2010s coincided with higher multiples. It also explains why, with real rates off the floor since 2021–22, markets have become more sensitive to growth and profitability surprises. None of this turns CAPE into a timing tool; its strength is as a long-horizon signal for expected real returns, not for calling turning points (Campbell and Shiller 1998; Research Affiliates 2012).

Intangibles and the Accounting Lens

Today’s market leaders are intangible-rich: software, data, brand, networks and R&D. Under US GAAP, most R&D is expensed rather than capitalised, which depresses reported earnings for innovative firms and mechanically lifts reported P/Es and CAPE relative to eras dominated by tangible capital (Lev and Gu 2016). When researchers capitalise R&D and other intangibles, the level of earnings and the cross-section of ‘value’ signals change meaningfully (Peters and Taylor 2017; Lev and Srivastava 2019). Changes in accounting rules also complicate simple comparisons with mid-twentieth-century data: goodwill amortisation was replaced with impairment-only testing, and share-based compensation moved onto the income statement, altering measured profits and therefore multiples (FASB 2001; FASB 2004). None of this completely ‘explains away’ higher valuations, but it weakens the case for strict mean reversion to twentieth-century averages.

Index Construction and Composition Effects

The S&P 500 is not ‘the market’; it is a curated, float-adjusted large-cap index with a financial-viability screen that biases it towards profitable survivors. That selection effect, alongside the rise of highly profitable mega-caps, can support a valuation premium over broader, less selective universes (S&P Dow Jones Indices 2024). Concentration raises another issue. When a small handful of firms account for a large share of index weight, index-level outcomes become more sensitive to a narrow set of fundamentals and regulatory or competitive shocks. That is a risk-management point rather than a forecast.

Access, Frictions and the Shape of Demand

Investing is radically easier and cheaper than in Benjamin Graham’s era. The first retail index fund dates to 1976; exchange-traded funds and zero-commission trading have since brought diversified exposures within reach of almost everyone. Lower frictions do not force overvaluation, but they plausibly raise the steady-state demand for broad, profitable large caps and help to entrench leadership at the top of the index (Bogle 2017; Schwab 2019). The key investor takeaway is behavioural: easier access makes it simpler to hold a diversified portfolio— and harder to justify stock-picking as a necessity.

Expected Returns Without Drama

You do not need a crash for returns to disappoint from elevated starting valuations. Expected nominal equity returns are linked to: (i) shareholder yield (dividends plus net buybacks), (ii) nominal earnings growth, and (iii) any change in the valuation multiple (Boudoukh et al. 2007). If the multiple merely holds, returns must roughly equal shareholder yield plus nominal earnings growth—typically a mid-single-digit to high-single-digit nominal range over a cycle. If the valuation multiple compresses towards more ordinary levels, the decade-ahead return outcome falls accordingly. CAPE’s historical usefulness lies exactly here: high starting valuations have been associated with lower subsequent 10-year real returns, on average, without saying anything precise about the path from here to there (Campbell and Shiller 1998; Fama and French 2002).

Figure 1. Line chart of the Shiller cyclically adjusted price–earnings ratio for the US market from 1950 to 2025. CAPE fluctuates between roughly 7 and 44. It rises through the 1960s (peaking around the low-20s), falls to single digits in the late 1970s and early 1980s, surges to an all-time high near the turn of the millennium (~44), compresses around 2009 (~15), then trends higher through the 2010s and early 2020s, ending in the high-30s in 2025.

Source: Robert J. Shiller, ‘Online Data,’ Yale University; accessed 18 August 2025.

So, Is This a Bubble?

On balance, ‘expensive and concentrated’ is the cleaner description than ‘1999-style bubble’. There are rational pillars for a valuation premium at present—the mix of lower inflation and real interest rates relative to previous eras of higher inflation and real rates; modern business models built on intangible assets with high operating leverage; and structural capital flows that favour large, profitable constituents (Cochrane 2011; Lev and Gu 2016).

The central risk is expectations risk: with a great deal of success already factored into prices, merely ordinary outcomes could disappoint going forward.

What This Means for Investors

First, avoid anchoring on twentieth-century averages as destiny. Structural changes in discount rates, accounting and index design, modern business models and unparalleled retail investor access to markets weaken simple mean-reversion arguments (FASB 2001; Cochrane 2011; Lev and Gu 2016). Second, expect less and diversify more. Keep core US exposure, but pair market cap-weight with global equities and, if desired, systematic tilts (value, profitability, size) to reduce single-name concentration risk without turning this into discretionary stock-picking madness (Asness, Frazzini and Pedersen 2019). Third, keep horizons aligned. Valuation is a long-run guide to returns, not a short-term trading signal (Campbell and Thompson 2008; Campbell and Shiller 1998).

References

Asness, Clifford S., Andrea Frazzini, and Lasse Heje Pedersen. 2019. ‘Quality Minus Junk.’ Review of Accounting Studies 24 (1): 34–112.

Baker, Malcolm, and Jeffrey Wurgler. 2007. ‘Investor Sentiment in the Stock Market.’ Journal of Economic Perspectives 21 (2): 129–151.

Bogle, John C. 2017. The Little Book of Common Sense Investing. 10th Anniversary ed. Hoboken, NJ: Wiley.

Boudoukh, Jacob, Roni Michaely, Matthew Richardson, and Michael R. Roberts. 2007. ‘On the Importance of Payout Yield.’ Journal of Finance 62 (2): 877–915.

Campbell, John Y., and Robert J. Shiller. 1998. ‘Valuation Ratios and the Long-Run Stock Market Outlook.’ Journal of Portfolio Management 24 (2): 11–26.

Campbell, John Y., and Samuel B. Thompson. 2008. ‘Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?’ Review of Financial Studies 21 (4): 1509–1531.

Cochrane, John H. 2011. ‘Presidential Address: Discount Rates.’ Journal of Finance 66 (4): 1047–1108.

Fama, Eugene F., and Kenneth R. French. 2002. ‘The Equity Premium.’ Journal of Finance 57 (2): 637–659.

FASB. 2001. Statement No. 142: Goodwill and Other Intangible Assets. Norwalk, CT: Financial Accounting Standards Board.

FASB. 2004. Statement No. 123(R): Share-Based Payment. Norwalk, CT: Financial Accounting Standards Board.

Greenwood, Robin, and Andrei Shleifer. 2014. ‘Expectations of Returns and Expected Returns.’ Review of Financial Studies 27 (3): 714–746.

Lev, Baruch, and Feng Gu. 2016. The End of Accounting and the Path Forward for Investors and Managers. Hoboken, NJ: Wiley.

Lev, Baruch, and Anup Srivastava. 2019. ‘Explaining the Demise of Value Investing.’ Critical Finance Review 8 (2): 95–144.

Peters, Ryan H., and Lucian A. Taylor. 2017. ‘Intangible Capital and the Investment-q Relation.’ Journal of Financial Economics 123 (2): 251–272.

Research Affiliates. 2012. ‘CAPE Fear: Why CAPE Naysayers Are Wrong.’ Newport Beach, CA: Research Affiliates.

Shiller, Robert J. n.d. ‘Online Data — Robert Shiller.’ Department of Economics, Yale University. Accessed 18 August 2025. https://www.econ.yale.edu/~shiller/data.htm

S&P Dow Jones Indices. 2024. S&P U.S. Indices Methodology. New York: S&P Dow Jones Indices.