Is There a Bubble in the Stock Market or Not?

Guest Editorial by Javier de Berenguer, Analyst and Fund Selector at MAPFRE Inversión

What the valuation metrics tell us…

Valuation multiples serve as a guide for the investment community to relate the amount of profit generated by a market or a specific company to its price. These ratios are very useful because they allow us to compare the market value of these companies not only over different periods of time, but also among the companies within the same industry sector.

Javier de Berenguer

So far, so good, but on their own, they are not a cure-all; it is important to know when to use them and how to interpret them.

Not all valuation multiples are a valid reference for every sector. Industries with higher growth potential often dedicate most of their capital to financing that growth, resulting in low profits (making the price/earnings [P/E] ratio invalid). In such cases, it is more appropriate to use multiples based on sales volume (e.g., price/sales). On the other hand, for more stable companies with mature businesses, the P/E ratio can be a good reference for valuing these companies. Similarly, for businesses with significant tangible book value—such as listed financial services or real estate—the P/E and P/B ratios are reliable benchmarks.

Once this is understood, let’s put the American market into numbers, which is currently the main focus of concern regarding valuation, and we will divide it into three groups: S&P 500, S&P 500 Equal-Weighted (EW), and the famous “Magnificent Seven.”

What the fundamentals tell us...

As we mentioned at the beginning of this article, these multiples are useful as long as we know how to use them, but above all, how to interpret them.

When looking at long-term valuation data (whether over 30, 15, or 10 years), all three groups — the S&P 500, the S&P 500 EW, and the Magnificent Seven — are trading at P/E ratios above their historical averages.

Although the market-cap-weighted S&P 500 shows the biggest deviation from its average, the broader market (not just technology and the Magnificent Seven) also presents valuation levels that can be described as demanding.

If we add fundamentals into the equation, the conclusions shift. Both ROE and Net Margin for these groups are currently above their historical averages and, in general terms, are expected to continue improving. The market-cap-weighted index (S&P 500) clearly shows higher returns and margins than the broader market. For example, the S&P 500 has an ROE (return on equity) around 19% and a margin of roughly 11%, while the equal-weight equivalent has noticeably lower profitability figures. This alignment between higher fundamentals and higher valuation multiples helps explain part of the premium assigned by the market.

Therefore, based on these data, the index would be trading at a P/E premium of 41% over its historical average, but it also has ROE and margin figures that are higher and roughly in line with that premium, which almost on their own could justify the valuation assigned by the market. However, it is worth remembering that, as mentioned earlier, the reliability of the multiple depends on the sector. So the question is: has the American market improved, or has its composition simply changed?

What the composition of the index tells us...

Reviewing what we have seen so far, we have a US market-cap-weighted index that has both increased its valuation and improved its fundamentals. On the other hand, the broader market is in a balance we could call “familiar,” when relating the P/E ratio to business metrics. This gap in valuation and fundamentals between the two indices has widened particularly strongly in recent years and has become more pronounced with the emergence of artificial intelligence, which has supported the technology sector, while the rest of the market has struggled on multiple fronts: inflation, geopolitical tensions, supply chain disruptions, the trade war, etc.

Over the past decades, the S&P 500 has steadily evolved into an index with a much larger weighting in technology (rising from around 10% in the late 1980s to roughly one-third today) and in communication services. This shift means the index now consists of businesses with lower physical capital requirements, higher cash generation, and greater scalability — characteristics that naturally justify higher valuation multiples than were typical in earlier periods.

Once we have examined the peculiarities of the American market, let us now move on to analyzing the comparison between the US stock market and the rest of the world.

But when compared with the rest of the international stock markets — is it expensive or cheap? And compared to other historical bubbles?

Contrary to what one might think, there are currently few safe havens in terms of indices or aggregated markets, even when the focus of analysis is outside the United States.

When comparing today’s valuations and fundamentals with those seen during previous market bubbles, the figures of the largest companies in the current index remain far from the extremes observed in episodes such as the dot-com era. The risks today stem more from the concentration of market capitalization in a small number of companies, and from the fact that passive investment vehicles leave many investors heavily exposed to this narrow group.

A comparison with historical bubbles (including the dot-com period) also shows that, while valuations are elevated, they are not yet at the levels associated with typical late-stage speculative excess. Fundamentally, today’s leaders are generating much stronger earnings and profitability than the companies that dominated previous bubble episodes.

But be careful, because there are always risks!

Given everything we’ve seen, we can draw both ‘bad’ and ‘good’ news from the points presented in this note. Starting with the positive, we are not in a bubble, and the evolution of the indices currently depends on continued growth in earnings and other metrics (ROE, margins) supporting the stock prices. On the negative side, there is no valuation buffer: the market is somewhat expensive, and there’s no shame in saying it.

However, there are factors that could continue to support the markets: a broader group of winners (more companies contributing to the index’s final return), efficiency improvements brought by artificial intelligence, or the start of a new earnings growth cycle in industries that have lagged behind. On the other hand, there are also macro variables that appear to provide support: abundant liquidity, stable economic growth, increased backing from monetary policy, and the implementation of substantial public investment commitments (defense, AI, digitalization, energy, etc.).

Another negative point, as we have already mentioned, is concentration: the lack of a valuation buffer and a highly concentrated market pushes us to increase diversification in portfolios, making it a key tool in managing these risks.

Regarding artificial intelligence, we must be attentive to what happens around its development, as this matter will determine whether we end up in a bubble or not. We are currently only two years into the race to master this new technology. One could say there is still a long way to go in terms of the volume of investment required and the number of participants that will join. The fact that it is a transformative technology attracting significant capital is precisely why we must monitor its development closely, as these have been characteristics that also appeared in other markets that eventually ended in a bubble.

Several classic bubble indicators are worth monitoring: rising participation, rapid inflows of capital, the emergence of new speculative players, and the increasing use of leverage to finance growth. Some of these elements are already visible in today’s AI investment cycle, while others are still in their early stages but showing signs of acceleration.

To conclude, it should be noted that from now on we need to pay closer attention to factors 3 and 4, that is, to observe how the development of AI is financed and how it increases the volume of participants.

So far, hyper-scalers (megatech) have been financing this development with cash flow, but we already have news that this is changing. (Alphabet and Meta have recently announced bond issues worth several trillions of dollars to finance AI) On the other hand, the concentration of technology among a few American companies is also decreasing; we are already seeing how other players within the semiconductor value chain are joining this wave of investments, also at a global level, especially in China where many efforts are being made to build a powerful ecosystem around it.

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Javier de Berenguer Viota, CIIA, CESGA, is an Investment Fund Selector and Financial Markets Analyst at MAPFRE Inversión. He has been with the MAPFRE group since 2017, working across both institutional asset management and wealth management. Javier’s work spans asset allocation, market analysis and investment due diligence, with a focus on global equity markets and multi-asset portfolios. He regularly contributes to MAPFRE’s investment commentary and analysis, particularly on valuation metrics, sector trends and market fundamentals.