We agree with the consensus view that stock valuations are elevated by traditional measures. But valuations should be considered in the context of the economic regime and earnings environment. Factoring in outlooks for economic growth, inflation, interest rates, and earnings, we are comfortable with the current 21 price-to-earnings ratio (P/E) for the S&P 500 Index. To justify a higher P/E and further moves higher from here, assumptions must be made about the path that these key drivers will take in coming months. We expect more of these factors to break positively than negatively, but it seems clear that a lot of optimism is currently being priced in. When the next bear market might arrive and where valuations will be at that time is difficult, if not impossible, to predict, but our best guess is that this bull market extends through 2027 (we define a bear market as a 20% decline on the S&P 500 based on closing prices). Gains beyond that will depend on whether the economy continues to grow, the path of interest rates and inflation, and the productivity gains (and potentially unemployment) AI brings.

Headlines surrounding the Middle East have dominated investor attention since late February. While uncertainty remains elevated, diplomatic negotiations have supported equities, even as fixed income and commodity markets continue to reflect potential risks. Recent economic data suggest the U.S. economy muddles on, though supply chain disruptions, higher shipping costs, and elevated energy prices are current headwinds. In our view, however, these pressures pose a greater risk to inflation than to economic growth. Below, we outline the implications for businesses and consumers.

In investing, the goal is to find assets that appreciate. That can be accomplished in different ways. One way is to find businesses that aren’t growing very fast but can be purchased at a low enough valuation that the investment can perform well. Another way to find potentially good investments is by identifying businesses (or groups of businesses that make up an index) that are growing rapidly but the market underestimates that growth.