“Uncertainty”

Wealth creation through financial markets is inherently volatile—a reality well-documented and widely experienced.

Volatility is the cost of pursuing long-term returns, and the steady upward trend of the 2023-24 market may have dulled investors’ awareness of a key fact: stock and bond prices decline nearly as often as they rise.

The calm of that period has given way to turbulence in 2025, with the Federal Reserve increasingly citing “uncertainty” in addressing inflation and recession risks—a sentiment shared by equity investors this year. Not unsurprisingly, the Federal Reserve has adopted a new buzz word to summarize this sentiment: “uncertainty”.

Tariffs, often blamed for recent volatility, can indeed exert upward pressure on prices by restricting the supply of goods and services compared to lower-tariff environments. However, tariff-driven inflation is not inevitable. This paper proposes an alternative driver of market unrest: structural overvaluation tied to a narrow cohort of mega-cap technology stocks. Over the past two years, equity markets delivered robust double-digit returns, propelled almost entirely by the “Magnificent 7” (Mag 7)—Nvidia, Amazon, Microsoft, Meta, Alphabet, Apple, and Tesla. Fueled by enthusiasm for artificial intelligence (AI), abundant stimulus liquidity, and record corporate profits, these stocks saw valuations soar, pushing the S&P 500’s forward 12-month price-to-earnings (P/E) ratio to over 22x at its peak (FactSet Earnings Insight), well above the 10-year average of 18.3 (excluding the 2008 crisis). In a capitalization-weighted index like the S&P 500, this growth amplified their influence, skewing the index’s composition.

In short, the market entered 2025 overpriced.

The “S&P 493,” a colloquial term for the remaining S&P 500 constituents, offers a clearer view of the broader U.S. equity market’s valuation. By contrast, the NASDAQ Composite, heavily tech-oriented and encompassing all Mag 7 stocks, reveals a stark divergence: its year-to-date performance stands at -10.2%, compared to the S&P 500’s -5.12% as of March 30, 2025 (MarketWatch). This gap underscores the tech sector’s overvaluation and its outsized role in driving recent losses. Beyond market performance, cracks are emerging in the U.S. economy, exacerbated by persistent inflation. The Federal Reserve’s preferred gauge, the Personal Consumption Expenditures (PCE) Index, rose 2.7% in February 2025—above expectations—signaling that rate cuts may be deferred (Investing.com). The Fed faces a dilemma: maintaining elevated short-term rates to combat inflation risks stifling economic growth through higher borrowing costs. Until inflation subsides, long-term bond yields are likely to reflect heightened expectations of future price pressures.

Traces of the post-COVID stimulus era—where $5 trillion flooded markets—linger in distorted asset valuations, favoring asset holders as inflation swelled. As one economist recently noted, “the era of easy everything is over” (Bowyer). While a recession is not certain, key indicators—waning consumer spending, a tightening labor market, and potential government downsizing—suggest headwinds. Yet, this reflects a functioning capital market adjusting to reality. A positive note is the re-emergence of an inverse stock-bond correlation, with investors seeking refuge in fixed income amid turbulence, signaling confidence in debt markets for now.

Ultimately, effective investment strategies prioritize long-term income needs and risk capacity over reacting to short-term volatility. We invite you to discuss your questions or review your financial plan with us if you have any questions.

Disclaimer: All information is for informational purposes. No information detailed here constitutes an offer to sell or buy a security. This summary does not constitute advice.  Investors should always seek investment advice specific to their unique financial situation and objectives.

The information presented here is for informational purposes only. No information detailed here constitutes an offer to buy or sell securities, advisory services, nor does the information constitute investment advice. Investors should always seek investment advice specific to their unique financial situation and objectives. Past results are not indicative of future results.

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References:

Bowyer, Jerry. “The Era of Easy Everything Is Over.” FT Portfolios, 14 Mar. 2025, www.ftportfolios.com/Blogs/EconBlog/2025/3/14/the-era-of-easy-everything-is-over.

FactSet Earnings Insight. “Highest Forward 12-Month P/E Ratio for the S&P 500 in More Than 3 Years.” FactSet, 11 Nov. 2024, insight.factset.com/highest-forward-12-month-p/e-ratio-for-the-sp-500-in-more-than-3-years#:~:text=In%20fact%2C%20prior%20to%20the,recorded%20on%20March%2023%2C%202000.Accessed 30 Mar. 2025.

Investing.com. “US Inflation Slightly Heats Up: Core PCE Index Rose 2.7% in February.” Investing.com, 28 Mar. 2025, www.investing.com/news/economic-indicators/us-inflation-slightly-heats-up-core-pce-index-rose-27-in-february-3954400. Accessed 30 Mar. 2025.

MarketWatch. “NASDAQ Composite Index.” MarketWatch, www.marketwatch.com/investing/index/comp. Accessed 30 Mar. 2025.