The stock market’s multiple might not be as high as it seems

Stocks notched a record closing high Tuesday, after a low-drama CPI report convinced the market the Fed will cut rates at its September meeting.

That gain extended a remarkable roughly 30% run since the market nearly fell into a bear market in April.

Is there much gas in the tank? Are valuations too stretched? Is the next move likelier to be up or down over the next few months?

Those are just some of the questions we wanted to pose to Savita Subramanian, an equity and quantitative strategist at Bank of America Securities and one of the most astute market watchers on Wall Street.

We got her on the phone Tuesday afternoon for a brief chat. Our conversation has been edited for clarity and concision.

Matt Phillips, Sherwood News: Maybe we should start with Q2 earnings. It’s been kind of a monster earnings season.

Savita Subramanian, BofA Securities: Yes. Earnings have come in much better than expected. We’re tracking something like a 6% beat on the bottom line.

We’ve actually seen almost 80% of companies beat expectations on revenue, which compares very favorably to something closer to 60% historically.

Analysts had marked down demand and sales expectations very aggressively on the idea that tariffs would start crimping margins, pricing power, and demand. And we haven’t really seen that.

Sherwood: I’ve been surprised not to see more of an impact from tariffs. Is that your experience, too?

Subramanian: I think the impact of tariffs is to be determined. We have seen a lot of pauses and we haven’t really seen major tariffs go through. I think that’s one of the risks.

The other thing that’s hard to disaggregate is how much of this recent demand that we’ve seen over the last couple of quarters reflects folks trying to get ahead of tariffs, which pulls forward demand before the price hikes go through. So those are the two risk factors.

But I do hear from companies that basically, they knew how to manage tariff risks. They just needed a number for the tariffs. Now that they have some numbers, they’re able to do what they did last time around, in 2018, which was shift sourcing and get more productive by thinking about efficiency.

Sherwood: And raise some prices where they can, right?

Subramanian: And raise prices, exactly. We are seeing some companies that still are able to raise prices.

Despite the fact that some of the jobs numbers are coming in softer, we’re not seeing broad layoffs. One could extrapolate that real wage growth is still relatively healthy, you know? Consumers aren’t necessarily feeling a lot of pain.

Sherwood: As long as people have jobs, I guess they can hang in there.

Subramanian: Yeah. In the US, that is the biggest component that drives spending. If you have a job, you spend your paycheck. If you don’t have a job, you don’t. That’s the single most important determinant — and so far, so good.

That’s the real risk that we’re watching for: widespread layoffs. We keep hearing rumors of this happening, but can’t find the corroborating data.

Sherwood: Though there were those revisions to the jobs report that came through recently that weren’t great.

Subramanian: Those were interesting because you still saw wage inflation, but you saw slower job growth. But unemployment was still relatively tight? I mean, it wasn’t like those reports showed we were in a weak labor market.

I feel like where we are right now is a Goldilocks-esque period for companies: they have some ability to raise prices, labor inflation is starting to alleviate, and they’re also being more efficient and using automation and maybe AI soon. So it’s all kind of coming up roses.

Sherwood: Sure, the earnings numbers have been good. But as you mentioned in one of your recent notes, a lot of those earnings — and arguably more — is already priced in, right?

You recently wrote that “the S&P 500 is pricier than it’s been in decades.”

Subramanian: That, in and of itself, isn’t reason to worry. This market is a different animal than what we’ve been looking at historically.

I always have a problem when people say the S&P is trading at its highest multiple of all time. That doesn’t even make sense because the S&P 500 has been so many different things over time.

Today, it’s mostly labor-light, asset-light sectors, whereas 20 years ago it was manufacturing and very labor intensive. The index has changed and one could argue it should trade at a higher multiple.

It’s also less levered than it’s been historically. Financials, energy, these are companies that used to be levered and risky. Now they’ve basically cleaned up their balance sheets.

Sherwood: Let me just stop you there and drill down on that. I think yesterday I saw the forward price-to-earnings multiple on the S&P 500 was something like 22.3x. I’ve covered markets for 15 years, give or take, and that’s pretty high.

But it seems like you’re saying you can justify that as a reasonable valuation given the change in the complexion of the index.

Subramanian: I guess there are two things.

One: yes, 22x sounds really high. But on the flip side, if you’ve looked at times in the past when markets saw big earnings recoveries or increases, multiples generally look high before those earnings come through.

So part of the reason multiples could compress from here is not just because of prices falling, but because of earnings actually accelerating. And I think the big risk is that earnings actually come in much better than expected from here.

But on top of that, if you think about the constituents of the S&P, you either have a bunch of tech companies and healthcare companies that have higher margins, or you have consumer, old economy companies that are about to see cost and efficiency benefits from deregulation as well as AI. I feel like this is a good setup.

Sherwood: So you think that the E in the P/E ratio could grow fast enough to bring down the multiple to a more normal-looking level. Is that right?

Subramanian: That’s exactly right. You look at next year’s earnings and analysts are forecasting 14% — I think it could be higher than 14% — growth in 2026. And when I say this, people look at me like I’m crazy because that would be a really outsized growth.

But think about where we are in the economy. We’re just coming out of a manufacturing recession. We’re in an environment where that capex boom in the US hasn’t yet materialized, but companies have planned all these projects and are just basically delaying them until they get some clarity around tariffs and taxes, which we now have.

We’ve got the One Big Beautiful Bill Act. We’ve had more tariff clarity. So a lot of really good things are happening now.

Sherwood: You sound pretty optimistic. Do you have a top-down target for the S&P 500?

Subramanian: The funny thing is, our target is not as optimistic as what I sound like. I think the reason for that is that we’re betting on a broadening out of the markets.

That might not drive us to a much higher level because the market itself has gotten so top-heavy in tech. And if tech doesn’t continue to crush it, gains are going to be much lower from here.

But look, there’s a lot of good news priced in at this point. We’ve heard good things from the administration. We’ve got a relatively healthy earnings backdrop. Corporations are guiding up.

But all this stuff is likely in the market and I guess my worry is that the surprise element might be in the negative direction in the near term.

Sherwood: So from an index-level or a market-level perspective, if Google and Meta and Microsoft start running into more headwinds, and like a 3M starts to get more efficient or productive or something like that, how does that net out to the index? It seems like an underperforming tech giant will have the bigger impact on the index.

Subramanian: Our year-end target for the S&P is 6,300. Our 12-month target is, I think, 6,600 at this point, maybe a touch higher.

We’re not expecting astronomical gains in the near term. I think what we’re expecting is better earnings growth and a broadening of the rally.

Maybe what makes more sense is to buy the Russell 1000 Value benchmark, which has more of these old economy companies. It might make more sense to buy the equal-weighted versus the cap-weighted index, because now you have potentially a broadening of earnings growth.

Up until a few years ago, the only capex that US companies did was they spent on technology. Everybody else was spending money on tech. Now you’ve got this very different dynamic where tech companies are spending money on everything.

What we’ve found is, you don’t want to buy the company spending the money on capex. You want to buy the companies getting the money. And if Big Tech companies are spending on power, buildings, concrete, and commodities and creating jobs, maybe that’s what you want to leg into.

Sherwood: Savita, this has been really excellent. Thank you so much for taking the time.

Subramanian: Absolutely.