The S&P 500's half-decade golden age of high valuations is over, Bank of America says

The days of high US stock valuations are over, says Bank of America’s Chief Investment Strategist Michael Hartnett.

Since 2020, investors have been willing to pay a premium relative to S&P 500 company earnings. So-called price-to-earnings ratios have been elevated thanks to mammoth stimulus efforts amid the pandemic and excitement around artificial intelligence developments. The optimistic outlook has propelled stocks to 146% gains from COVID-19 lows.

Over that time, S&P 500 PE ratios on a trailing 12-month basis have barely dipped below 20 times and have risen as high as 41x. The average PE ratio during the last five years was just shy of 26x. But Hartnett said in a client note on Thursday that things are going to start trending toward historical norms.

Since 2000, the S&P 500’s average PE ratio has been 20x. During the entire 20th century, the index’s average valuation was 14x. Hartnett predicts that 2025 will mark the end of the era of elevated valuations.

“We say 2025 big picture is peak valuations in stocks and credit, following glory of past 5 years,” Hartnett wrote.

“20x has been floor for S&P 500 P/E in first half of 2020s, a decade of magnificent US exceptionalism augmented by fiscal excess and AI boom,” he continued. “20x we say new ceiling for P/E as globalization reverses, Fed less independent, fiscal/monetary excess ends, 3-4% new inflation normal outside recessions, US savings rate rises.”

Equity valuations measure how expensive stocks are on a relative basis by looking at how much investors are paying compared to the earnings that companies actually generate.

Other valuation measures, like the Shiller cyclically-adjusted PE ratio, show that US stocks remain at some of their most expensive levels in the last century.

When valuations climb too high, long-term forward returns have historically been muted.

For valuations to come down, stock prices either have to fall or earnings have to live up to or outperform elevated expectations.

Given macro risks as President Donald Trump’s trade war threatens a recession and another bout of inflation, Hartnett sees pain ahead for stock prices. Instead, he’s bullish on safer assets like bonds and gold, as well as on international stocks — for the next couple of months, at least.

“We remain H1 buyers of dips in bonds, international & gold, sellers of SPX/US$ rallies,” he wrote.

One way investors can gain exposure to these trades is through funds like iShares Core US Aggregate Bond ETF (AGG), the Vanguard Total International Stock ETF (VXUS), and the SPDR® Gold Shares (GLD).

But it remains unclear whether a recession will materialize in the months ahead. Trump has shown that he will step back from hardline stances if investors react unfavorably.

Still, 10% baseline tariffs remain on most imports, and an inflationary episode could hurt spending. Payrolls and inflation data in the coming weeks should give investors insight into the health of the economy.