For investors firmly bullish on the stock market, the forward price-to-earnings (P/E) ratio is often a powerful tool to refute claims of a market bubble. Although the AI boom has pushed major indices to record highs, this metric, commonly used by fundamental analysts, suggests stock valuations are becoming more attractive. The underlying logic is that while stock prices have surged recently, Wall Street's expectations for corporate earnings growth are even more rapid.
Data shows that one year ago, the S&P 500's forward P/E ratio was 22.4x, but as of the recent close, it has dropped to 20.51x, even though the index gained 20% during the same period. With earnings season approaching, the market generally expects constituent companies to achieve double-digit profit growth for the seventh consecutive quarter, with overall earnings growth expected to exceed 23%. However, whether this growth pace can be sustained remains uncertain.
Analysis indicates that although current stock valuations appear high relative to historical levels, corporate earnings growth has significantly deviated from long-term trends. Viewed through the Shiller P/E ratio, the S&P 500 is currently valued at about 41 times earnings, approaching historical highs seen during the internet bubble twenty-five years ago. More alarmingly, current earnings conditions differ significantly from that period; back then, corporate earnings growth was relatively moderate, whereas now earnings per share growth far exceeds the long-term trend line.
If recent abnormally strong earnings growth is adjusted back to more normal levels, the S&P 500's Shiller P/E valuation would skyrocket to 67.6x, a level exceeding the peaks of all other asset bubbles in US history. This implies the current market may not just be a price bubble, but is approaching a price bubble built upon an earnings bubble. Supernormal profits are likely unsustainable, and investors will eventually have to face financial reality.
As large tech giants continue to invest heavily in building AI data centers, corporate profit models are changing. These companies are shifting from previous asset-light models to asset-heavy models, with rising capital expenditure. The likelihood of earnings growth ultimately returning to normal levels is increasing. Earnings bubbles have appeared many times in history; before the Global Financial Crisis, the banking and real estate development industries experienced similar situations, where seemingly low P/E ratios masked unsustainable profit growth.
More broadly, earnings bubbles often appear in industries with boom-bust cycles, including natural resources, airlines, shipping, and the semiconductor industry in the current environment. Wall Street analysts often find it difficult to accurately judge when an earnings bubble reaches its peak. Once a turning point emerges, the stock market may face the risk of a sharp decline. Some perspectives suggest US economic growth is insufficient to support the earnings levels currently expected by Wall Street, indicating risks in the market's optimistic expectations for corporate earnings.
The US stock market has experienced some volatility recently. Previously, strong momentum trading in semiconductor stocks that drove the market up showed signs of slowing, but subsequently semiconductor stocks rose again, pushing the Nasdaq Composite Index back up. According to latest data, the S&P 500 closed less than 1% from its historical high, while the Dow Jones Industrial Average surpassed the 53,000-point mark for the first time, setting a new historical record.
