Dear traders, dear stock market friends.
The US equity markets came under significant downward pressure in some cases in the past trading week, leading to a fall in the S&P 500 of 1.6 %. The correction was triggered by concerns about the very high valuations of AI shares and increasingly tense market breadth.
Concerns about the market overheating
The price rally in recent months has led to a historically high valuation of the S&P 500. At 220 %, the so-called Buffett indicator, which measures the ratio of total US stock market capitalization to GDP, signals that the market will be as expensive in 2025 as it was at the height of the dotcom bubble.
Other key figures also confirm the high rating:
- The cyclically adjusted Shiller P/E ratio of the S&P 500 is close to 40.
- And the forward P/E ratio for the next twelve months is just under 23.
- The forward P/E ratio of the Nasdaq-100 even rose to around 27-28 points.
At the same time, the majority of the index gains are attributable to a small number of stocks. The technology sector now accounts for 35 % of the S&P 500's weighting, and the Magnificent 7 (Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia and Tesla) also combine for around 35 % of the index's total market capitalization. At around 8 %, Nvidia alone weighs as much as the smallest third of the index combined.
The ratio between the S&P 500 Equal Weighted Index and the “normal” S&P 500 Index weighted by market capitalization has therefore fallen to its lowest level since 2003.
The combination of record-high multiples and the strong index weighting of the leading stocks therefore makes the index susceptible to corrections should the narrative of the AI boom change.
Historically high earnings growth in the current reporting season
Historically, however, a high valuation is not an indicator of poor forward performance for the S&P 500, especially when strong growth is behind the high valuation.
The current Q3 reporting season is exceeding even optimistic expectations: For 91 % of S&P 500 companies already reporting, „blended“ earnings growth is +13.1 % year-over-year. This is the fourth consecutive quarter of double-digit growth and thus the longest such streak since 2021. At the same time, sales rose by +8.3 %, the highest figure since Q3 2022. The net operating margin also rose to a new record high of 13.3 %.
However, it is noticeable that the momentum is once again strongly concentrated on the Magnificent 7, whose EPS growth is significantly above the market average.
With a forward P/E ratio of 22.7, the S&P 500 is clearly trading above the five- and ten-year averages. This would only be justifiable if the expected earnings growth of around +12 % for 2025 and +14-16 % for 2026 actually holds. If earnings growth collapses or the megacaps deliver disappointments, there is a risk of a noticeable multiple contraction. The sustainability of earnings growth is therefore one of the most important factors for the medium-term development of the equity market.
Market breadth cools in the short term
As mentioned above, market breadth plays an important role when it comes to the "health" of a bull market. As soon as there is a clear divergence between the development of the index and the development of market breadth, this would be a clear warning signal. Although the recent weakness in market breadth was a short-term warning signal, the signals from the analysis of market breadth are still bullish in the medium to long term.
The Advance Decline Line (one of the most important market breadth indicators) is still in a clear uptrend and rose to a new all-time high at the end of October, thus confirming the long signal in the S&P 500. The decline in the last two weeks therefore merely represents a correction within the long-term uptrend. The next important signal in the A/D line will be a breakout above or below one of the zones marked with the red lines.
S&P 500 Equal Weighted Index with relative weakness
Another interesting index from the area of market breadth analysis is the S&P 500 Equal Weighted Index, also mentioned above. In contrast to the S&P 500, which is weighted by market capitalization, each company has exactly the same index weighting, namely 0.2 % (100 % / 500). The following chart shows that the Equal Weighted Index is showing relative weakness in the current year; however, this is not necessarily a negative signal for the broad market as long as the index is in an upward trend. However, if the index falls below the support level of 7,500 points, there is a risk of further losses, at least in the short term.
Rebound on Friday evening
After the S&P 500 came under significant pressure over the course of last week, a strong countermovement followed on Friday evening. After interim losses of just under 1.5 %, the index even closed slightly higher on Friday, generating a clear reversal signal above the daily EMA 50 (green). This signals a return of the bulls and increases the probability of a recovery in the new trading week.
The VIX also formed a clear reversal signal on Friday. After rising to 22.72 points over the course of the day, the “fear barometer” closed the weekend at 19.08 points and below the psychologically important 20-point mark.
Author: Tobias Schmid
Date: 10.11.2025
