Are US Stocks Rising Yet Becoming 'Cheaper'? S&P 500 Up 22% While Valuations Fall, Corporate Earnings Drive the Trend

In an era dominated by 'shrinkflation,' consumers have grown accustomed to the disappointment of shrinking product sizes and reduced quality at the same price—chocolate peanut butter cups, for instance, may now contain little more than 'chocolate candy' and 'peanut butter cream.' Yet in the stock market, investors are unexpectedly enjoying a 'more for less' deal.

According to Barron's, over the past year, the S&P 500 index has surged 22%, but stock valuations have not risen accordingly—in fact, they've declined.

Bloomberg data shows the index's forward price-to-earnings (P/E) ratio has dropped from 22.1x to around 20x. In other words, investors are now paying less for more value.

The key driver behind this phenomenon, analysts say, is that corporate 'earnings' growth has clearly outpaced 'stock price' appreciation.

FactSet data reveals that Q2 earnings season was remarkably strong: 86% of companies reported profits above market expectations, surpassing the historical average of 78%. Moreover, S&P 500 constituents' Q2 earnings surged 50.4% year-on-year.

However, this earnings boom isn't solely fueled by artificial intelligence (AI) themes. Julian Emanuel of Evercore ISI noted, 'Q2 earnings further confirm the strength in tech and energy, but more surprisingly, earnings growth has broadly spread across industries and subsectors.'

More importantly, this strong performance is expected to continue. Analysts typically lower earnings forecasts at the start of a new quarter, but this time, the market defied convention—instead of downgrading, it raised Q3 earnings expectations by 0.3%.

Yet this 'perpetual bullish' sentiment has begun to raise red flags among some investment experts. Megan Horneman, Chief Investment Officer at Verdence Capital Advisors, admitted the earnings season was impressive, but warned that 'upward earnings revisions seem endless,' a sign of growing 'complacency' in the market.

Still, some market participants question the 'quality' of these earnings. Short-seller Jim Chanos argues that the accounting treatment of AI spending may be artificially inflating corporate profits. Equipment suppliers can recognize revenue quickly, while companies purchasing the equipment take much longer to expense those costs.

This may partly explain why the tech sector's P/E ratio has declined more sharply than the broader market. However, earnings growth isn't confined to AI-related industries—the improvement is widespread across the market. Even non-AI sectors, such as consumer staples, have seen stock prices rise over the past year without a corresponding increase in valuation levels.

Some believe the strength of earnings growth has rendered short-term valuation metrics less meaningful.

David Rosenberg of Rosenberg Research points out that the 'Cyclically Adjusted Price-to-Earnings' (CAPE) ratio, proposed by Robert Shiller—measuring the S&P 500's current price against the 10-year average of earnings—has risen to levels rarely seen since the dot-com bubble.

Yet the gap between forward P/E and CAPE reveals another message: the market expects next year's earnings to far exceed the 10-year average, prompting questions about whether using 'dot-com era' earnings benchmarks to evaluate today's companies is still appropriate.

Nonetheless, market skepticism hasn't fully dissipated.

Although AI heavyweights like Amazon (AMZN-US) and Alphabet (GOOGL-US), Google's parent company, have seen tech stocks rebound about 12% from July lows due to strong cloud revenue, analysts caution that not every dollar spent on AI will ultimately translate into tangible returns.