Is the Mania Continuing?

Executive Summary

Overvaluation in the stock market has reached such extremes even a Federal Reserve Bank governor, Lisa Cook, uncharacteristically mentioned it in her quote included below. I have also included data below to give substance to the proclamation. Forward earnings per share projections are often overly optimistic. The first graph below shows how disconnected the price of S&P 500 is from even these optimistic estimates. The second graph shows the forward P/E ratio was only higher during the Technology Bubble, which resulted in substantial declines. The skew of the Magnificent 7 is clear in the fourth graph. The overall S&P 500 earnings growth forecast is +1%, while 493 of the stocks included are negative and the MAG 7 is up 18%. Extreme bubbles have historically not ended well, caution should be exercised. 

Please proceed to read The Details below for more information.

“Favorable surprises are easy to handle. It’s the unfavorable surprises that cause the trouble.”
–Charlie Munger

The Details

The mania in the stock market continues as we begin 2025. The extremes I have been writing about for some time are now being acknowledged by other professionals. For instance, as written on MarketWatch.com, a Federal Reserve governor made an uncharacteristic announcement. [emphasis mine]

“Federal Reserve governor Lisa Cook on Monday gave one of the bluntest warnings an official at the central bank has ever delivered about the stock market.

‘Valuations are elevated in a number of asset classes, including equity and corporate debt markets, where estimated risk premia are near the bottom of their historical distributions, suggesting that markets may be priced to perfection and, therefore, susceptible to large declines, which could result from bad economic news or a change in investor sentiment,’ Cook said.”

To add substance to this proclamation, I will review a few graphs. The following graph from financial advisor, Lance Roberts, compares the always optimistic “Forward” Earnings-per-Share (EPS) estimate to S&P 500 performance. Even using forward EPS, the gap has grown tremendously.

The chart below from The Kobeissi Letter shows how the S&P 500 Price-to-earnings ratio using forward EPS estimates compares to prior years. The only years it was higher was during the Technology Bubble. Of course, technology stocks, as represented by the Nasdaq 100 Index, subsequently plummeted over 83%!

And the graph below, from Isabelnet.com, shows how earnings projections are led by the Magnificent 7 stocks. When removed from the total, consensus forward earnings for the remaining 493 stocks are negative at -4%.

And to show the consistency of overvaluation, departing from earnings, the following graph from Bank of America Global Research, which was included in a post from The Kobeissi Letter, shows that the S&P 500 Price-to-Book Ratio at 5.3x is higher than the peak of the Technology Bubble, and is 77% higher than its long-term average of 3x.

Although the S&P 500 Index reveals stock market mania, looking under the hood, it is highly concentrated in seven stocks. The more concentrated the gains, the more risk imbedded in the overall stock market.

Just as during the 1920’s and 1990’s, the current bubble seems stretched beyond comprehension. How much further it goes depends upon the sentiment of speculators. Once speculators determine the safety of cash or Treasuries is more appealing, the bottom will drop out, as has occurred at the end of every “super- bubble” before.

With the economy teetering on the edge of recession, as evidenced by many indicators; long-term interest rates defying the Feds cuts in the Fed Funds Rate; and trouble in many large economies abroad; extreme caution should be exercised by speculators today.

The S&P 500 Index closed at 5,942, down 0.5% for the week. The yield on the 10-year Treasury Note fell to 4.60%. Oil prices increased to $74 per barrel, and the national average price of gasoline according to AAA rose to $3.06 per gallon.