The Valuation Challenge to Stock Prices

Preface: Explaining our market timing models

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

 

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

 

 

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
• Trend Model signal: Bullish (Last changed from “bearish” on 27-Jun-2025)
• Trading model: Neutral (Last changed from “bullish” on 31-Jul-2025)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
 

Subscribers can access the latest signal in real time here.

Nosebleed Valuations

The S&P 500 ended September trading at a forward P/E of 22.8, which is the highest level this century. Other valuation indicators are also showing elevated readings compared to their long-term averages. How worried should U.S. equity investors be?
 

In addition, the Fed’s Q2 Financial Accounts report showed household allocations have risen to a record high of 50.2%. While this is not a market timing indicator, and equity allocations are not age-adjusted for the effects of the Boomer demographics, it is nevertheless a warning that forward 10-year S&P 500 returns are likely to be subpar.
 

No Signs of a Top

My long-term market model remains on a buy signal, based on a positive crossover of the monthly MACD (bottom panel) of the NYSE Composite. Sell signals are generated when the 14-month RSI (top panel) flashes a negative divergence of a lower reading as the index makes a higher high, which is not the case in the current circumstances. I interpret this as an indicator of positive price momentum.
 

 

In addition, investors are seeing evidence of positive fundamental momentum. S&P 500 quarterly EPS estimates are rising.

 

 

Time for a Breather?

Despite my bullish intermediate-term view, there are numerous signs that the advance has been too much and too fast. Nautilus Research studied past instances of the S&P 500 rising 85% without a -10% correction. While the sample size is relatively small (n=13), returns over the next 1–3 months have been weak.
 

 

I am concerned about the breakdown in the NYSE McClellan Summation Index (NYSI). Past breaks have been signals of market pullbacks.
 

 

MarketWatch reported that Nicholas Colas of DataTrek Research found that the daily return correlations of the five major S&P 500 sectors, technology, industrial, consumer discretionary, financial and healthcare, to the S&P 500 fell to unusually low levels, which reflects excesive investor confidence: “Every other time they have done so since 2023, the S&P 500 has declined by 5% to 18% in the following weeks.”
 

 

 

Bullish or Bearish?

How can investors square the circle of challenging valuations and equity allocations with evidence of positive price and fundamental momentum?

 

I offer the following framework for analysis. Valuation defines your downside risk, or how high you are in a building if you were to fall out (because of the onset of a bear market), but changes in fundamentals and prices tell you whether you are at risk of an imminent bear market.

That said, the market is extended and can correct at any time. One key risk is a market tantrum over the effects of tariffs, which begin to be felt in Q3 and Q4. I would closely monitor corporate signals from Q3 earnings season for signs of tariff-related margin squeezes. The accompanying shows core CPI (blue line) steady at about 3%, but PPI (red line) rising. This is an indication of an acceleration in input prices while consumer price increases stay steady. Either margins will be squeezed or demand slows because of higher prices from tariff pass-through.
 

Goldman Sachs found that October has the second high level of earnings pre-announcements. This is likely attributable to companies adjusted market expectations for the full fiscal year that ends in December.
 

In conclusion, while elevated valuations and excess equity allocations pose risks to long-term returns, I see no signs of an imminent U.S. equity market top. The intermediate bull case is supported by both price and fundamental momentum. However, the advance is extended and stock prices could correct at any time. One key risk is the emergence of a tariff-induced margin squeeze that could derail the short-term fundamental outlook.