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August 12, 2025

Is the Stock Market Too Hot?

The S&P 500 struck another all-time high today, following this morning’s Consumer Price Index (CPI) report. Inflation in July came in somewhat lighter than expected at 2.7%.

Stocks have been performing quite well lately. This has prompted the usual speculation about the big correction lurking around the corner.

Wall Street and the financial media have a tendency to get negative whenever there is a strong stock market rally. This time, however, there may be something more to their bearishness.

The professional investment community by and large dropped the ball during the April sell-off. The current rally is a bit of an embarrassment for them.

Fearing a disastrous policy mistake that could bring down the global economy, institutions dumped stocks in April. Meanwhile, individual investors bought, as we recently discussed in How Mom and Pop Beat the Pros.

The S&P 500 is now up more than 25% from early April levels, when many on Wall Street were advising clients to sell or refrain from buying. With share prices materially higher, it follows that many of these same people would now be drawing attention to valuation risk.

Tariff Derangement Syndrome

Treasury Secretary Scott Bessent has referenced “Tariff Derangement Syndrome” in media interviews, a variant of the more widespread “Trump Derangement Syndrome.”

Today’s CPI report is important, because it further erodes the widely believed narrative, which Fed Chair Jerome Powell has himself articulated, that Trump’s tariffs will spark an inflationary spiral.

Inflation rates for certain categories that one might consider vulnerable to tariff pressures actually came in quite light—including appliances, electronics and apparel.

Despite the good news, we are seeing quotes from many Wall Street prognosticators who insist that the inflation pressure is still en route. A Goldman Sachs strategist, for example, said today that “[t]ariffs have yet to drive substantial price increases…”  

When it comes to investing, the problem with TDS (either kind) is that it clouds one’s judgments. Any Trump policy position is automatically harmful, and the degree of harm it will bring tends to get exaggerated.

Dislike and/or distrust of Trump has a tendency to channel one’s thoughts towards negative outcomes. When you are surrounded by people who share the same attitude, the problem only compounds.

Even though the administration has either cut deals or is in the final stages of negotiation with almost all major trading partners, many voices in the professional investment community and financial media continue to pound the table on tariffs.

As we noted back in April, extremely high tariffs that disrupt global trade and cause supply chain chaos would indeed be harmful to growth and potentially inflationary.

But we are now well past the point of tariff worst case scenarios and have a much clearer view of the administration’s philosophy on tariffs and trade.

In May, a Financial Times columnist coined the derisive catchphrase Trump Always Chickens Out (TACO) to describe Trump’s tendency to pause or reduce tariff rates.

Rather than characterizing Trump’s flexibility as weakness, we view it as smart strategy.

Panicked investors dumped shares in April because they feared massive across the board tariffs. We now see that the administration is using tariffs in a relatively careful, almost surgical, manner to achieve multiple goals.

A key point that many investors have missed is that if a certain type of tariff or tariff rate is going to be particularly problematic, the administration is prepared to make necessary adjustments.

The gold bar kerfuffle

A recent example is confusion over whether imported gold bars would be subject to tariffs in light of the current 39% tariff rate applicable to Switzerland, a country that has not yet reached a deal with the U.S.

Switzerland happens to be the world’s largest gold refining hub and accounts for a majority of global gold bar production. Applying high tariffs to gold bars made in Switzerland would have been potentially very disruptive to the gold market.

On Monday, August 11, Trump clarified in a Truth social post that “Gold will not be Tariffed!”

After rising a few percentage points at the end of last week on concerns of supply shortages, the gold price has retreated to levels that prevailed before the issue surfaced.

The episode is instructive in that it shows the administration’s willingness to pivot when its tariff policies have unintended consequences.

Stagflation?

Notwithstanding all the trade deals and demonstrations of flexibility when specific tariffs threaten to cause unique market disruptions, a lot of the negativity out there continues to hinge on tariff impacts.

The concern is that tariffs will hurt economic growth and at the same time create inflationary pressure, which will prevent the Fed from cutting interest rates.

Wall Street strategists are sounding alarms that the US economy is drifting toward stagflation as the impact of trade tariffs start to show up, potentially restricting the ability of the Federal Reserve to slash interest-rates.  While investors have so far largely shrugged off the warning signs, data is suggesting an approaching period of sticky inflation and sluggish economic growth, the analysts said. - Bloomberg (8/7/2025)

While we agree that extremely high tariff rates could be damaging, effectively shutting down global trade, moderate tariffs are an entirely different story.

We acknowledge that moderate tariffs (in the 10% to 20% range typical of countries that have reached deals) could possibly result in some one-time upward pricing pressure on certain goods.

But to the extent tariffs on specific items become especially problematic, like the above-mentioned gold bar scenario, they can and likely will be modified. This also applies to tariffs on crucial commodities and manufactured goods that American businesses find difficult to absorb.

Meanwhile, tariffs are generating much needed revenue for the federal government and diverting demand to U.S. producers. As we have also seen, tariff negotiations are leading to large foreign investments in U.S. industrial capacity, which is pro-growth and ultimately disinflationary.

Tariffs are expected to generate approximately $300 billion in revenue in 2025, according to Scott Bessent. This is certainly a large sum, but it represents only about 1% of U.S. GDP and just over 5% of total federal revenues.

Investors worried about tariff impacts on the economy should at the very least take comfort in the limited scale of tariffs in the context of the broader economy.

Are valuations too rich?

While tariff risk has been in our view persistently overstated, the big upward movement in stocks since April does leave us with a different valuation environment. Prices are higher than they were, leading many to question if they are now too high.

Concerns like this are nothing new, and to some extent, reflect healthy market functioning. Investors should constantly question if prices imply an overly optimistic view of business prospects.

Thanks to AI, it is now easy to go back in time and find numerous examples from years back of investors looking at rising share prices and calling for a crash. In March 2015, Forbes asked, Are U.S. Stocks Overvalued?, citing higher price/earnings multiples.

When this article was written just over ten years ago, investors were worried that stocks, especially growth/tech stocks, had become too richly valued. With the benefit of hindsight, we now see these concerns were entirely misplaced.

The S&P 500 has more than tripled since that article was published, while the tech-heavy NASDAQ Composite has more than quadrupled.

S&P 500 and NASDAQ Composite

(Total return since March 2015)

If investors were sitting on the sidelines a decade ago, perhaps because valuations seemed high relative to some historical metrics, what they missed out on was a tremendous sustained boom in tech sector earnings.

These stocks may have looked expensive, but they were in fact cheap, as innovations like cloud computing were about to breathe new life into many tech business models.

The stock market is not the economy

There is a tendency to view stocks as a reflection of the larger economy. Clearly, a healthy economy and a healthy stock market go hand in hand, but the relationship between the two is actually quite complicated.

The stock market generally represents the most advanced layer of business activity within the entire economy. Just ten stocks currently account for nearly 40% of the market capitalization of the S&P 500.  

All of these stocks are technology or technology platform companies, with the exception of the tenth ranked name, financial holding company Berkshire Hathaway (BRK), whose stock portfolio is actually more than one-quarter Apple (AAPL).

Investors a decade ago who were focused on historical averages were basing their decisions on previous stock markets that had a completely different complexion.

Back in 2013, for example, energy giant Exxon Mobil (XOM) was at one point the most valuable stock in the index. Today, it is barely in the top 20 and has less than a 1% weighting.

Historical comparisons are interesting but run the risk of comparing apples with oranges. What really matters for overall index returns going forward is how successful the mega-cap giants of the index will be as they seek to capitalize on AI.

But even if we look at earnings multiples in a historical context, we do not see a particularly disturbing picture.

S&P 500, Growth, Value

(Forward P/E Multiple - Last 10 Years)

Growth stock earnings multiples have advanced sharply from April levels, but, at 30 to 35 times, are in the middle of the range they have occupied for about the past five years.

It is true that growth stock earnings multiples have expanded since the first half of the past decade, when they were more like 20 to 30 times. But in retrospect, those multiples woefully understated the growth potential of the companies they applied to at the time.

Meanwhile, the forward earnings multiple of the value component of the S&P 500, at around 15 to 20 times, is completely in line with levels that have prevailed over the past decade.

The multiple on the overall index is slightly higher, driven primarily by the growth component.

Shifting monetary policy

In addition to tariff impacts, investors have been concerned about labor market weakness and pressures on the consumer. A disappointing jobs report led Trump to replace the economist who runs the Bureau of Labor Statistics, a move that has naturally stirred controversy.

While the economy overall seems stable and healthy, a closer look reveals what could be described as two parallel economies.

We see a tech-driven high-end economy that is benefiting from the AI boom and wealth effects. This portion of the economy is what tends to be disproportionately captured by the stock market.

Then there is the low-tech economy (housing, autos, consumer spending) that is being held back by high interest rates.

To the extent we see labor market weakness in the private sector, this appears to be taking place in the low-tech economy.

While companies like Meta (META) drop pay packages worth hundreds of millions on AI superstars, working class Americans, whose savings were eviscerated by the post-Covid inflation wave, are struggling with high rates on mortgages, auto loans and credit card balances.    

To the extent this labor market weakness persists, this will allow the pendulum to shift more in the direction of easier monetary policy and rate cuts. The high-tech names that dominate the S&P 500 may not need a rate cut, but they will benefit from it.

Selecitivity is key

Investors should always be worried about valuation but need to maintain broader perspective. Yes, stocks have moved up sharply since April, but the S&P 500 is only up about 9% since the start of the year—a healthy rise but not an extreme move.

The stock market as a whole was clearly too cheap in April. The opportunity to buy the dip in the S&P or the NASDAQ has passed.

While valuations are not currently extreme, they are definitely fuller, so it makes sense in the current environment to be more careful in terms of where one picks one’s spots.

We continue to be encouraged by many positive factors.

AI represents an innovation wave that is following its own trajectory, largely independent of macroeconomic forces. Growth in AI is led by tech juggernauts with exceptional balance sheets and cash flow that are making long-term investments in the future.

Not all tech stocks will necessarily benefit from AI, however.

Shares of graphics software giant Adobe (ADBE), for example, are down nearly 25% year to date. With AI models producing incredible graphics for free or at very low cost, investors have grown concerned that ADBE will be disrupted by AI rather than benefit from it.

AI has the potential to drive productivity higher, which will likely be good for the economy and stock market as a whole, but there will be some casualties along the way among legacy business models, which need to be avoided.  

Meanwhile, as reasonable trade deals get done and favorable inflation data flows through, tariff-related risks are subsiding.

And then there is the prospect of rate cuts, which may be needed to support job growth in the low-tech portion of the economy—and possibly even the high-tech portion, as AI replaces engineers and computer programmers.

Staying the course

After a period of sharp gains, there is a natural psychological instinct to “lock in profits.” Behavioral economists call this the disposition effect.

While we discourage long-term investors from attempting to time the stock market as a general matter, we see the recent upside as validation of an attractive economic backdrop, rather than an indicator of risk.

Within our Model Portfolios, we remain cognizant of somewhat elevated valuations but remain focused on the solid long-term fundamentals that underpin these investments—and in many cases are only looking stronger.

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