- S&P 500 index sets new highs as ‘buying on the dip’ pays off again
- Hopes for peace in the Middle East turn attention back to strong Q1 earnings season in the USA
- Splurge on artificial intelligence by the Magnificent Seven fuels much of the market gains
- US equities still look expensive by historic standards
- Bulls only succumbed to bears in 2000 and 2007 after disappointing earnings from tech stocks and financials respectively left valuations exposed
“After paddling sideways since late summer last year, the S&P 500 index is brushing aside March’s brief stumble that followed the outbreak of war in the Middle East and moving to new all-time highs,” says AJ Bell investment director Russ Mould.
“Of the major markets only Japan and Brazil can point to better capital returns over the past year, and indeed in 2026 to date, despite the uncertain geopolitical backdrop, uncomfortably high oil prices, and the risk of further presidential policy caprice.
“There are several reasons why investors are once more putting faith in the USA, after 2025’s doubts over the Federal debt, the impact of tariff policies and massive investments in artificial intelligence (AI) weighed on share prices and the dollar and drove up yields on US Treasuries.
“The key now is to stress-test those reasons, check out their durability and reassess the ultimate arbiter of investment return, which is valuation. Is the good news already priced in, or not?
Source: LSEG Refinitiv data. *Local currency terms, to close on Friday 8 May.
“FactSet’s earnings estimates for 2026 put the S&P 500 on a forward price/earnings (PE) ratio of 21 times. This compares to the FTSE 100’s forward rating of 13 times, based on aggregate consensus analysts’ estimates for the UK’s premier stock index.
“This may suggest UK stocks offer the better value, but it is easy to argue that US equities deserve a premium rating, at least to some degree, for five reasons:
- The US is home to the world’s largest stock and bond markets, its reserve currency, and the deepest pools of venture capital, so entrepreneurs and companies can get ready access to appropriately priced, even cheap, funding for their businesses, especially for innovative technologies.
- Regulation tends to have a lighter touch and there is also little or no stigma attached to either enormous wealth or a business failure, so risk-taking is encouraged, not penalised.
- The 401k investing and saving culture is more deeply embedded, thanks in turn to the lesser social security safety net that is available Stateside.
- America is the world’s largest economy, so US firms get benefits of scale from serving it, to the benefit of profit margins.
- US companies are run harder. Staff get fewer holidays, unions have less power and management teams focus ruthlessly on the quarterly earnings number.
“However, none of this is ‘news,’ as such, and dangers do still lurk.
“There is scope for a political shift to the left owing to the development of, and desire to deal with, powerful quasi-monopolies and wealth inequality; presidential interference could yet manifest itself in the workings of the US Federal Reserve; prior debt accumulation may crimp future spending by government and consumers alike, to the detriment of corporate profits; and widespread use of derivative instruments, margin debt and prediction markets could accentuate the losses suffered by investors to a scary degree, just as they are currently boosting profits and fuelling widespread optimism in the outlook for US equities.
“The 1910s, 1920s, 1970s and early 2000s respectively offer uncomfortable precedents for some or all of these potential dangers, with episodes of considerable financial market turbulence and upset the result on each occasion.
“In this context, it is interesting to note that the S&P 500 stands at a premium to its 20-year average forward PE of 19 times, let alone how the index’s cyclically adjusted price earnings (CAPE) ratio – as devised by Professor Robert Shiller to take a 10-year view adjusted for inflation and interest rates – is about as high as it has ever been.
“The CAPE ratio, by Professor Shiller’s own admission, is not a timing tool, by any means. Even so, it is easy to see how prior attempts to pile into US equities with the CAPE multiple at current levels have come unstuck and led to poor investment returns on a 10-year view.
Source: Robert Shiller data
“There is also the danger that investors are paying historically high multiples for historically high profits. The spending splurge in AI is driving earnings and US GDP growth and tempting analysts and investors to extrapolate the current growth trajectory into future years.
“However, investors walked straight into the market collapses of 2000-02 and 2007-08 under similar circumstances, as rapid growth and new record highs in earnings quickly gave way to a nasty dip, as the key drivers of those profits crumbled. The bust in the broadband and 3G mobile telecoms spectrum took care of the tech, media, and telecoms bull run of the late 1990s and the collapse of the real estate market ended a period of financial alchemy as far as the banks were concerned in the middle of the following decade.
Source: FactSet, Standard & Poor's Research
“Such a long-term perspective is not deterring too many investors right now, and ‘buying on the dip’ seems to be working for US equities yet again, and there are several cogent explanations for this, too:
- The strategy has a good track record that goes all the way back to the emerging market debt crisis of 1997-98. If the going gets tough, then investors are accustomed to central banks saving the day with interest rate cuts, bailouts, or unorthodox monetary policy.
- Talks between Washington and Iran have begun and a ceasefire declared. If this means the risk of escalation is behind us then the next logical steps are de-escalation and then peace, even if the journey may not be a smooth one.
- If that is the case, the threat to inflation, growth, government finances, and interest rates from higher oil and gas prices could be more limited than initially feared. Investors can therefore focus on the prospect of interest rate cuts under the chair-elect Kevin Warsh and Republican efforts to boost the US economy in 2027, when the race to the White House in the 2028 presidential election begins in earnest.
- The US may be more sheltered than most from higher oil prices, thanks to the ongoing boom in domestic production. The US is self-sufficient as output from shale oil fields continues to rise, thanks in some part to President Trump’s exhortation to drill and keep drilling.
Source: US Energy Information Administration
- The first-quarter earnings season is off to a strong enough start to justify consensus analysts’ earnings growth forecasts of 19% for 2026 and 16% for 2027 for the S&P 500 overall, to new all-time highs in each year. Research from FactSet also shows that the technology sector leads the way, with consensus forecasts pointing to 38% earnings growth this year and 25% in 2027, thanks to artificial intelligence.
Source: FactSet
- Finally, research from Goldman Sachs suggests that algorithm-driven and hedge funds were short in mid-March and have been caught off guard by the rally, with the result that they have had to cover those positions by buying equities, to create a multi-billion-dollar short squeeze.
Source: LSEG Refinitiv data
“A surge in the Refinitiv Most Shorted stocks index backs up the final argument and hints that the US equity rally may be technical, rather than fundamental, in origin.
“That in turn suggests the foundations of the rally may not be as strong as they seem, especially as much rests upon AI delivering lofty productivity gains and returns on investment, and market breadth is narrow.
“The aggregate stock market capitalisation of the so-called Magnificent Seven sits at a record high of $23.6 trillion, or 37% of the S&P 500’s total stock market capitalisation. That septet has also provided 53% of the total increase of the S&P 500’s market cap over the past year and 40% of the increase generated in 2026 to date.
Source: LSEG Refinitiv data
“Such narrow markets either tip over or see investors seek to rebalance in the end, but no-one knows when or where that tipping point rests.
“The technology, media and telecoms bubble did not peak until March 2000, after all, and it only did so when failure to meet lofty earnings growth expectations bumped into equally lofty valuations.”
