Bank of America’s Chief Investment Strategist, Michael Hartnett, is signaling a pivotal shift for U.S. equities, warning that the S&P 500’s era of sustained high valuations is nearing its end.
Since 2020, investors have consistently paid a significant premium relative to company earnings, fueled by unprecedented stimulus measures during the pandemic and optimism surrounding advancements in artificial intelligence.
This enthusiasm helped drive a 146% surge from the COVID-19 market lows. Throughout this period, the S&P 500’s trailing 12-month price-to-earnings (P/E) ratio rarely dipped below 20x, reaching as high as 41x, with an average hovering just under 26x. However, Hartnett cautioned in a client note on Thursday that these elevated valuation levels are unlikely to persist and that markets are poised to return to historical norms.
Since the start of the 21st century, the S&P 500’s average P/E ratio has settled around 20x. Looking further back, the average valuation during the entire 20th century was closer to 14x. Hartnett projects that 2025 will mark the peak of the current valuation cycle.
“We believe 2025 will represent peak valuations in equities and credit, following the extraordinary performance of the past five years,” he wrote. “Throughout the early 2020s, 20x served as a floor for the S&P 500’s P/E ratio, a period defined by U.S. exceptionalism fueled by fiscal largesse and the AI boom.
Moving forward, we expect 20x to become a ceiling, as de-globalization accelerates, Federal Reserve independence erodes, fiscal and monetary excesses diminish, inflation stabilizes at 3–4% outside of recessions, and the U.S. savings rate rises.”/br>
Valuation metrics like the P/E ratio help wealth advisors and investors assess how expensive stocks are relative to the earnings companies generate.
By historical standards, the U.S. equity market remains richly valued. For example, the Shiller cyclically-adjusted P/E ratio, a more comprehensive long-term valuation metric, still signals that U.S. stocks are among the most expensive they have been in the past century. Historically, periods of elevated valuations have often led to lower forward returns.
To bring valuations back in line with historical norms, either stock prices must decline, or corporate earnings must meaningfully outperform expectations. Given the current macroeconomic backdrop — including the risks posed by ongoing trade tensions under President Donald Trump’s administration and the threat of a potential inflationary surge — Hartnett expects downward pressure on equity prices.
He remains cautious on U.S. stocks and the dollar and instead favors more defensive positioning, including bonds, gold, and international equities, at least through the first half of the year. “We continue to recommend buying dips in bonds, international equities, and gold, while selling rallies in the S&P 500 and the U.S. dollar,” Hartnett advised.
For advisors seeking actionable ideas, Hartnett’s positioning suggests looking at broad-based vehicles such as the iShares Core U.S. Aggregate Bond ETF (AGG) for fixed income exposure, the Vanguard Total International Stock ETF (VXUS) for global equity diversification, and SPDR® Gold Shares (GLD) to tap into potential strength in precious metals. These instruments offer accessible avenues for reallocating client portfolios toward assets that may prove more resilient in a shifting economic and market environment.
Still, uncertainties remain. Although Trump has demonstrated flexibility in retreating from hardline policies when markets react negatively, a baseline of 10% tariffs persists across most imported goods. If inflationary pressures reaccelerate, consumer spending — a critical pillar of U.S. economic growth — could weaken, posing further risks to corporate earnings. Upcoming data releases, particularly on payrolls and inflation, will be critical for assessing the strength of the economic cycle and will likely influence market sentiment in the coming months.
The broader message for wealth advisors is clear: The tailwinds that supported historically high stock valuations over the past five years are dissipating. Portfolio strategies that succeeded in an environment of easy fiscal policy, Fed accommodation, and speculative AI-driven optimism may require reevaluation as markets transition to a more normalized, and potentially more volatile, regime.
Adjusting client expectations around future equity returns — and emphasizing diversification across asset classes — will be essential in navigating this evolving landscape.
