Is the Stock Market Overvalued? What Traders Should Watch Next
The S&P 500 has set 28 record highs this year and sits near 6,664. But valuations are stretched to dot-com era levels, making many traders ask:
Is this a sustainable rally or a risk of stock market overvaluation waiting to play out? The next few weeks — with Fed policy, earnings, and bond yields in focus — could provide the answer.
Why valuations are flashing warning signs
- CAPE ratio: Highest since the late 1990s bubble.
- Forward P/E: ~23x next 12-month earnings, stretched vs. historical averages.
- Momentum drivers: Half of 2025’s 14% gain tied to earnings growth, half to multiple expansion — a delicate balance.
Bulls’ case: Earnings and the Fed
Goldman Sachs raised its S&P 500 year-end target to 6,800, citing strong forward earnings growth and the Fed’s dovish pivot.
David Kostin expects earnings to remain the primary driver, while Ed Yardeni sees forecasts at record levels — $295/share in 2025 and $305/share in 2026.
Historically, when the Fed cuts interest rates amid economic growth, the S&P 500 posts a median 12-month return of +15%.
Bears’ case: Inflation, yields, and jobs risk
- Inflation data: Could challenge assumptions of continued cuts.
- Labor market: Weakening job market risks are feeding into earnings downgrades.
- Bonds: Rising 10-year yields would imply skepticism about growth and pressure on equity multiples.
If yields break higher while earnings soften, the downside impact to equities could outweigh the benefit of Fed easing.
Trading implications
- Day traders: Anchor VWAP on inflation/jobs releases; fade failed breakouts in SPY/QQQ if yields tick higher.
- Swing traders: Overweight sectors with earnings visibility (XLK tech, XLY discretionary) if data supports growth. Shift to defensive positions (XLV healthcare, XLP staples) if job data weakens.
- Bond-equity watch: Use 10-year yield (TNX) as a trigger. Yield >4.5% = risk-off bias; yield <4% = green light for growth rallies.
Bottom line
Valuations are undeniably stretched, but earnings and Fed cuts could keep the rally alive into 2026.
The question of stock market overvaluation won’t be answered in headlines alone — it will hinge on whether earnings deliver and bond markets validate growth expectations.
Traders should stay flexible: lean into growth if yields ease, but rotate defensively if macro data cracks the foundation.