Trillion Dollar Market Caps: Fairy Tale Pricing or Business Marvels?

     Stock markets have always rewarded winners with large capitalizations, and with each new threshold, the questions begin anew of whether animal spirits or fundamentals are driving the numbers. A few weeks ago, Nvidia seemed unstoppable as its market capitalization crested $5 trillion, and while markets have turned skeptical since, the core questions have not gone away, and the answers come from two extremes. At one end are the "realists”, who view themselves as rational, above the fray and entirely data-driven, who argue that there is no business model that can support a value this high, and that Nvidia is overvalued. At the other end are the “AI true believers”,  who believe that if the market the company is going after is big enough, and they see AI as such a market, the upper bounds on value are released, the sky is the limit. As someone who entered the Nvidia sweepstakes early (in 2018) and has held it through much of its magical run, while expressing reservations about its pricing running ahead of its value, especially in the last three years, I will try to thread the needle (unsuccessfully, I am sure) in this post. In fact, rather than try to convince you that the company is under or overvalued, which is really your judgment to make, I will offer a simple model to reverse engineer from any given market capitalization, the revenues and profitability thresholds you have to meet, and allow you to come to your own conclusions.

A History of Market Cap Thresholds

    In 1901, US Steel was created  when Andrew Carnegie and J.P. Morgan consolidated much of the US steel business, with an eye to monopolizing the steel business, and the company became the first global firm with a market capitalization of a billion dollars, a small number in today's terms, but a number that was three times larger than the Federal budget in that year. The twentieth century was a good one for the US economy and US stocks, and the thresholds for highest market cap rose along the way:

Note the long stretch between Microsoft hitting the half-a-trillion dollar market cap in 1999, as the dot com boom peaked, and Apple doubling that threshold in 2018. Note also the quickening of the pace, as Apple hit the $2 trillion and $3 trillion market capitalization thresholds in the next four years, and Nvidia continued the streak hitting $4 trillion in 2024 and $5 trillion in 2025.  

    The table does provide a starting point to discussing multiple themes about how the US economy and US equities have evolved over the last century. You can see the shift away from the smokestack economy to technology , in the companies hitting the thresholds, with US Steel and GM firmly in the old economy mode, Microsoft, Apple, and Nvidia representing the new economy, and GE, with its large financial service arm, operating as a bridge. Having been in markets for all of the thresholds breached since 1981, the debate about whether the company breaking through has risen too much in too short a time period has been a recurring one. 

1. Substance: To get a measure of operating substance, I looked at the revenues and net income in the year leading into the year in which each company broke through the threshold. As you can see, US Steel had revenues of $0.56 billion and net income of $0.13 billion in 1901, the year in which its market cap exceeded $1 billion. GM, at the time its market cap breached $10 billion, had revenues of $9.83 billion, on which it generated net income of $0.81 billion; if PE ratios are your pricing metric of choice, that would have translated into a PE ratio of 12.35. Between 2018 and 2022, as Apple's market cap tripled from $1 trillion to $3 trillion, its annual revenues increased by 72%, and its net profits almost doubled. Finally, coming to Nvidia, the surge in market cap to $4 trillion in 2024 and $5 trillion in 2025 has come on revenues and net income that are about a quarter of the size of Apple's revenues and net income.
2. Life cycle: Every company that climbed to the top of the market cap tables and hit a market cap threshold historically has had single-digit revenue growth in the year leading up, with two exceptions: Microsoft in 1999, which was coming off a 28% revenue growth rate in 1998, and Nvidia in both 2024 and 2025 coming off even higher growth rates. Using this revenue growth rate in conjunction with the ages of the companies involved, I think it is fair to conclude that there has been a shift across time, with the mature companies (older, lower growth) that were at the top of the list for much of the twentieth century to much younger companies with growth potential rising to the top in this one.
3. Investment returns: Looking at the returns in the years after these companies hit their market cap thresholds, the results are mixed. While buying Apple in 2018, 2020, or 2022 would have yielded winning returns, at least over the next year or two, buying Microsoft in 1999 would not. In some of these cases, extending the time horizon would have made a difference, for the positive with Microsoft and for the negative with GE.

From a rational perspective, you could argue that these thresholds (billion, half a billion, trillion, etc.) are arbitrary and that there is nothing gained by focusing on them, but in a post that I wrote in September 2018 on Apple and Microsoft becoming trillion-dollar companies, I argued that crossing these arbitrary thresholds can draw attention to the numbers, with the effects cutting both ways, drawing in investors who regret missing out on the rising market cap in the periods before (a positive) and causing existing investors to take a closer look at what they are getting in return (perhaps a negative).

Market Caps: Pathways to Intrinsic Value Break Even

    Debates about whether a company is worth what it is trading for, whether it be a billion, ten billion, a hundred billion, or a trillion, devolve into shouting matches of "he said, she said", with each side staking out divergent perspectives on value and name-calling the other. Having been on the receiving end of some of that abuse, I decided to take a different pathway to examining this question. Rather than wonder whether Nvidia is worth five trillion or Eli Lilly is worth a trillion, I framed the question in terms of how much Nvidia or Eli Lilly would have to generate in revenues to justify their market capitalizations. The reason for my focus on revenues is simple since it is relatively unaffected by accounting games and can be compared to the total market size to gain perspective.

    The tool that I plan to use to arrive at this breakeven revenue is intrinsic valuation, and I chose not to use the acronym "DCF" deliberately. A discounted cash flow valuation (DCF) sounds like an abstraction, with models driving discount rates and financial modeling driving cash flows. To me, a DCF is just a tool that allows you to assess how much you would pay for a business or  the equity in the business, given its capacity to generate cash flows for its owners. Since it is easy to get lost in the labyrinth of estimates over time, I will simplify my DCF by doing two things. First, since our discussion is about market capitalization, i.e., the market's estimate of the value of equity, I will stay with an equity version of the model, where I focus on the cash flows that equity investors can get from the business and discount these cash flows back at a rate of return that they would demand for investing in that equity. In its most general form, this is what an equity valuation yields:

To simplify the assessment further, I structured this model to value equity in a mature company, i.e., one growing at or below the nominal growth rate of the economy in the very long term and again for simplicity, assumed that it could do this forever. The value of equity in this mature, long-lasting firm can be written as follows:

To put this model into use, let's take the $5 trillion dollar market capitalization that Nvidia commanded a few weeks ago and assign the following general inputs:

1. Cost of equity: Every month, I estimate the implied cost of equity for the S&P 500, and that number is model-agnostic and driven by what investors are willing to pay for stocks, given their fears and hopes. At the start of November 2025, that number was about 8%, with higher required returns (9-12%) for riskier stocks and  lower expected returns (6-7%) for safer stocks.
2. Inflation rate: While inflation has come down from its 2022 highs, it has stayed stubbornly above 2%, which the Fed claims as its target, and it seems more realistic to assume that it will stay at 2.5%, which is consistent with the riskfree rate being about 4%.
3. Stable growth rate (nominal growth rate in the economy): This is a number that is in flux, as economists worry about recessions and economic growth, but since this is a long-term number that incorporates expected inflation, it seems reasonable to assume an expected nominal growth of 4% for the economy (about 1.5% real growth). 

The net profit margin for Nvidia in the most recent twelve months has been 53.01%, an exceptionally high number, and the return on equity it has earned, on average over the last five years, is about 64.44%. I know that these numbers will come under pressure over time, as competition for AI chips picks up, and Nvidia's biggest customers (and chip maker) push for their share of the spoils, but even if you assume that Nvidia can maintain these margins, the revenue that Nvidia would have to deliver to justify its value is $483.38 billion.

Since Nvidia is still growing and you may need to wait, as equity investors, to get your cash flows, this breakeven number will get larger, the longer you have to wait and the lower the cash yield that equity investors receive during the growth period. In fact, with Nvidia, if you assume that it will take five years for them to grow to steady state, and that equity investors will receive a cash yield (cash flow as a percent of market cap) of 2% a year, the estimated breakeven revenue increases to $677.97 billion. The table below maps out the effects of waiting on breakeven revenues for a range of cash yield:

Download breakeven revenue spreadsheet

If, as seems reasonable, you assume that net margins and return on equity will decrease over time, the revenues you would need to break even will expand:

Download breakeven revenue spreadsheet

In fact, if you are a low-margin company, with net margins of 5% (as is the case with even the very best-run discount retailers) and a more modest return on equity of 10%, you will need revenues of $8 trillion or more to be able to get to a market capitalization of $5 trillion. 

    This framework can be used to compute breakeven revenues at other firms, and in the table below, we do so for the twelve largest market cap companies in the world, at their market capitalizations on November 20, 2025:

Note that, for simplicity, I have used a 2% cash yield and 4% growth rate in perpetuity for all of these firms, and that the breakeven revenues reflect current net margins and returns on equity at each of these firms, but with that said, there is still value in looking at differences. To allow for this comparison, I forecast out breakeven revenues five years from now, and estimated the growth that each company would need over the five years to justify its current market cap. Not surprisingly, Aramco can get to its breakeven revenues in year 5 with almost no growth (0.59% growth rate) but Tesla needs to deliver revenue growth of 86.4% to break even. Broadcom, another company that has benefited from the market's zeal for AI, has the next highest cliff to climb  in terms of revenue growth. In fact, for all of the Mag Seven stocks, growth has to 15% or higher to breakeven, a challenge given their scale and size.  In dollar value terms, three companies will need to get to breakeven revenues that exceed one trillion by year 5 to breakeven, Apple, Amazon and Tesla, but the first two are already more than a third of the way to their breakeven targets, but Tesla has a long, long way to go.

From Breakeven Revenues to Investment Action

    While some are more comfortable replacing conventional intrinsic valuation, where you estimate value and compare it to price, with a breakeven assessment, the truth is that the two approaches are born out of the same intent.

The Economics of Breakeven Revenues

    The model that I used to compute breakeven revenues is a vastly simplified version of a full equity valuation model, but even in its simplified form, you can see the drivers of breakeven revenues.

1. Market Capitalization: Since we work back from market capitalization to estimate breakeven revenues, the larger the market capitalization, holding all else constant, the greater the breakeven revenues will be. Using just Nvidia as an example, the company has seen its market capitalization rise from less than $400 billion in 2021, to $1 trillion in 2023, $2 trillion and $3 trillion thresholds in 2024 and crossed the $4 trillion and $ 5 trillion market cap levels in 2025. As the market cap has risen, the breakeven revenues have increased from $200 billion at the $1 trillion mark to $600 billion at the current market cap.
2. Operating Profitability: There are two profitability metrics in the drivers, with net margins determining how much of the revenues a company can convert to profits and the return on equity driving the reinvestment needed to sustain growth. Higher profitability will allow a company to deliver a higher market capitalization, at any given level of revenues. One reason manufacturing firms like Tesla will need higher breakeven revenues than software firms is that the unit economics are not as favorable.
3. Interest rates and equity risk premiums: The level of interest rates and equity risk premiums determine the cost of equity for all company, with higher values for the latter pushing up the costs of equity for riskier companies higher, relative to safer companies.
4. Operating and leverage risk: The riskiness in a business will push its cost of equity higher, and a higher debt load (relative to market cap) will have the same effect. A higher cost of equity will raise the breakeven revenues needed to deliver the same market capitalization.

In sum, while the breakeven revenue that you need to justify a given market cap always increases as the market cap increases, its level and rate of rise will be governed by business economics.

The 3Ps: Possible, Plausible, and Probable

    Replacing a conventional intrinsic valuation with a breakeven revenue analysis still leaves open the final investment question of whether that breakeven revenue is a number that you are comfortable with, as an investor. To address this question, I will draw on a  structure that I use for intrinsic valuation, where I put my assessment through what I call the 3P test.

It is possible that once you compute the breakeven revenues for a firm and measure it up against reality that it is impossible, i.e., a fairy tale. The most obvious case is when the breakeven revenues that you compute for your firm exceeds the total market for the products or services that it provides. If there is a lesson that tech companies learned in the last decade, it was in making the total addressable market (TAM) for their market into almost an art form, adding zeros and converting billion dollar markets into trillion dollar TAMs.  If you pass the "it is possible" test, you enter the plausibility zone, and nuance and business economics enter the picture more fully. Thus, assuming that a luxury retailer with sky-high margins and small revenues, by staying with a niche market, can increase its revenues ten-fold, while keeping margins intact, is implausible, as is a net margin of 40% in stable growth for a company with gross margins that are barely above that number. Finally, assuming that revenues can multiply over time, without reinvesting in acquisitions or projects to deliver those revenues are also pushing the boundaries of what is plausible. Once breakeven revenues pass the possible and plausible tests, you should be on more familiar ground as you look at the entire story line for the company, and assess whether the combination of growth, profitability and reinvestment that you are assuming with your story has a reasonable probability of being delivered.

    To apply these tests, consider Nvidia and Tesla. Nvidia needs about $590 billion in revenues by 2030 to break even at its current market capitalization of $4.3 trillion, requiring a growth rate in revenues of about 26% for the next five years. While that is a reach, it is both possible and plausible, with continued growth in the AI chip market and a dominant market share for Nvidia providing the pathway. It is on the probable test that you run into headwinds, since competition is heating up, and that will put pressure on both growth and margins. The problem for Tesla is that if the net margin stays low (at 5.31%), the revenues needed to breakeven exceed $2.2 trillion, and even with robotics and automated driving thrown into the business mix, you are pushing the limits of possibility. A Tesla optimist, though, would argue that these new businesses, when they arrive, will bring much higher net margins, which, in turn, will push down breakeven revenues and bring it into plausible territory. 

The Aggregated 3P Test - Big Market Delusion

    We tend to ask the 3P question at the company level with the companies that we choose to invest in (and like), but as we construct what look like plausible and probable stories for these companies, and invest in them accordingly, there are other investors are asking the same questions about the companies that they invest in, many of which compete in the same business as yours. That may sound unexceptional to you, but when the market that these companies are competing in is very large and still in formation, you can end up with what I described almost a decade ago as the big market delusion. In a paper on the topic, I used the dot.com boom, the cannabis stock surge and online advertising as case studies to explain how this behavior is a feature of big markets

The AI storyline clearly fits the big market delusion. There is talk of a "huge" market for AI products and services, with little to show as tangible evidence of that market’s existence right now, and that potential has drawn massive investments in AI architecture from tech companies. Along the way investors have also fallen under the spell of the big market, and have pushed up the market capitalizations of almost every company in the space. Using the language of breakeven revenues, investors in each of these companies is attributing large breakeven revenues to their chosen companies, but the delusion comes from the reality that if you aggregated these breakeven revenues across companies, the market is not big enough to sustain all of them. In short, each company passed the possible and plausible test, but in the aggregate, you are chasing an impossible target.

    While the big market delusion is at play in every aspect of AI, one segment where it is most visible right now is in the Large Language Models (LLM) space, where high profile players like ChatGPT, Gemini, Grok and Claude are vying for users, and their creators are being rewarded with nosebleed pricing. OpenAI, while still unlisted, has used the early lead that ChatGPT gave it in the LLM race to attract investments from a host of big tech companies (including Nvidia and Amazon) and venture capitalists, with the most recent investors pricing it at $500 billion, an astonishing number, given that the company reported revenues of only $13 billion in the most recent twelve months. Anthropic, the creator of Claude, has seen its pricing jump in the most recent funding round (from Microsoft and Nvidia in November 2025) to $350 billion, fifty times its revenues of $7 billion in the last twelve months. Elon Musk's owners stake in xAI, Grok's originator, was estimated to be worth $230 billion in November 2025, again an immense multiple of its revenues of $3.2 billion (if you include combined revenues with X). Expanding the list to the large tech companies, it is undeniable that some of Alphabet's massive rise in market capitalization in 2025 is because of its ownership of Gemini, and that Meta (with Llama) and Amazon (with Nova) have also seen bumps in market capitalization. Finally, while Deepseek is no longer making headlines, it is also in the space, competing for business. In the aggregate, LLM ownership is being priced at $1.5 trillion or more, and the collective revenues, even generously defined, are less than $100 billion. It is entirely plausible that a big market exists for LLMs, and that one or even two of the players in this space will be winners, but in the aggregate, the market is overreaching.

The Management Effect

     The mechanics of the breakeven revenue process may make it seem like managers are bystanders in the process and that investing can be on autopilot, but they are not. In fact, when market capitalizations rise, and breakeven revenues run well ahead of current revenues, I would argue that management matters more than ever. Going back to the breakeven revenues that we computed for the twelve largest market cap companies in the world, I would make the case that management matters much less (if at all) in Aramco and Berkshire Hathway, where breakeven revenues are close to current revenues, and the investments needed to deliver those revenues have already been made, that at the companies that still have steep climbs ahead of them to get to breakeven revenues.

    In this context, I will reemphasize a concern that I raised at the height of Meta's metaverse investing fiasco, which is that investors at many tech companies, including most on the large cap list, have given up their corporate governance rights, often voluntarily (through the acceptance of shares with different voting rights), to founders and top management in these companies. When traditional corporate governance mechanisms break down, and top managers have unchecked power, there is an increased risk of overreach. That concern is multiplied in the LLM space, where Sam Altman (at OpenAI) and Elon Musk (at xAI) are more emperors than CEOs.

The Investing Bottomline

    I started this post with mentions of market cap thresholds being breached, as the market pricing pushes up into the trillions for some of the biggest stock market winners. But what are the implications for investors? 

1. Highly priced ≠ Overpriced: If you are an investor who considers any highly priced company to be overvalued, I hope that this post leads you to reconsider. By reframing a pricing in terms of breakeven revenues, profitability and reinvestment, it allows you to consider whether a stock, even if priced at $4 trillion, may still be a good buy. 
2. The 3P test: Once you compute the operating metrics you need to breakeven on an investment in a highly priced company, passing those metrics through the 3P test (Is it possible? Is it plausible? Is it probable?) allows you to examine each company on its merits and potential, rather than use a broad brush or a rule of thumb (based on PE ratios or revenue multiples).
3. Room to disagree: I have never understood why, even if you believe strongly that a stock is over or under priced, that you need to evangelize that belief or contest people with alternate views. I think that the pathway that you would need (in terms of revenue growth and profitability) to justify Nvidia's and OpenAI's current pricing is improbable, but that is just my view, and it is entirely possible that you have an alternate perspective, leading to the conclusion that they are undervalued.
4. Reality checks: No matter what your view, optimistic or pessimistic, you have to be open to changing your mind, as you are faced with data. Thus, if you have priced a company to deliver 20% growth in revenues over the next five years (to break even) and actual revenues growth comes in at 10%, you have to be willing to revisit your story, admit that you were wrong, and adapt. 

If you came into this post, expecting a definitive answer on whether Nvidia is overpriced, you are probably disappointed, but I hope that you use the breakeven spreadsheet to good effect to make up your own mind.

YouTube

Spreadsheets

1. Breakeven Revenue, given market capitalization

A Golden Year (2025): Gold's Price Surge - The Signal in the Noise!

    I grew up in India in a time where if you had wealth, your investment options were limited. A stock market with sparse listings, accompanied by a lack of trust in financial assets, led investors to put their wealth into tangible assets. Real estate was the most common choice but gold was a strong competitor, though investments in the latter often took the form of jewelry and ornaments. As financial markets have gained dominance across the globe, especially so in the last four decades, gold has retreated to the background, with lagging returns in most years. In 2025, as stock and bond markets climbed walls of worry almost nonchalantly to reach new highs, gold has also been a surprisingly big winner, building on a recovery that started in 2022 to crest $4000 an ounce in October 2025. For long term proponents of investing in gold, this has been vindication, but even for investors who have never held gold in their portfolios, there is a message from the gold's rise that they ignore at their own peril. I must confess that I have never felt the draw of gold, and have never held it in my portfolio, but I have always been fascinated by the hold that gold has on some investors, and the reasons for its longevity. In this post, I will start by first positioning gold in the investment continuum and then examining its price movements, both in 2025 and with a longer term perspective, to get a handle on the drivers of these movements, before looking at how gold may fit in investment portfolios. 

Gold: Commodity, Currency or Collectible?

    I have argued that all investments can be classified into one of four groups - assets, with expected cashflows, either contractual (fixed income) or residual, commodities, which derive their value from use as inputs into production of other products or services, currencies, used as mediums of exchange and stores of value, and collectibles, held for their scarcity and enduring demand. This categorization matters because it provides a starting point for discussions of how to attach prices to each:

With assets, you can estimate value based on expected cash flows and risk. but you also price them based upon demand and supply. With commodities like oil or iron ore, you may be able to estimate value, based upon aggregated demand and supply, but it is far more likely that pricing will dominate. With currencies and collectibles, the absence of expected cash flows makes pricing the only option, making mood and momentumkey variables determining pricing direction.

    To assess gold as an investment, we need to first start by classifying it and while it is not an asset, it can or has been a currency, a commodity and a collectible at different points in history and in different forms. 

• It is an inefficient currency, and while there are undoubtedly transactions where gold coins have been used as tender, difficulties associated with checking authenticity, security and breaking down into small units have limited its use through history. 
• It can be used as a commodity, as is the case when it is used to make jewelry or statues (or in tooth fillings), but even when used in this context, it is often held more for its value as a collectible than for aesthetic reasons. 
• It is as a collectible that gold has stood out, with governments, banks and individuals attaching value to it over time.

Thus, it is safe to say that it is gold's role as a collectible that has driven its pricing over time. To the question of "so what", there are implications that follow almost immediately, and that will animate our discussion of gold's performance in 2025:

• Since gold, absent cash flows, cannot be valued, arguing whether gold is under or over valued is a pointless one, just as it is for bitcoin. In fact, if your investment philosophy is strictly tethered to finding investments that are under valued by the market, gold will not have a place in your portfolio, explaining Warren Buffett's long standing aversion to it, as an investment. It is worth noting that Berkshire Hathaway did invest in Barrick Gold, but an investment in a gold mining company has expected cash flows and is thus an asset.
• Gold is priced every day, and that pricing process is driven by demand and supply, and while we will outline macro variables that can affect one or both, it is ultimately a process where mood and momentum will carry the day. 
  

Without doubt, gold is one of the longest standing collectibles, predating and outliving its competitors. So, what is it that explains gold's durability as a collectible? The following factors come into play, and in the process of assessing them, we can get some insight into gold's enduring standing:

1. Scarcity: The supply of gold is not fixed, since more gold can be extracted, but it is finite. At the start of 2025, there were approximately 244,000 metric tons of gold in the world, held in a variety of forms (jewelry, gold bars & coins etc.). While gold production in 2024 amounted added 3,000 tons to this quantity, it is estimated that that there about 60,000 metric tons of gold that are still in reserves. That puts it in a sweet spot between elements like platinum that are too scarce (about 10,000 metric tons) to be widely held, and more difficult to extract, and elements that are too plentiful to hold their value. 
2. Durability: For a collectible to hold its value, it has to be durable, and one of the reasons that gold acquired its collectible status is because it is chemically stable, malleable and does not oxidize or corrode (when it comes into contact with acids and other agents). 
3. Desirability: There is something about gold that exerts a hold on human beings. From the Greek myth of Midas, the king whose touch turned everything to gold, to the legend of El Dorado, a city made of gold, that led the Spanish to cross the ocean to seek it out in South America, gold has driven narratives and altered history. 

Clearly, gold is not the only collectible, but almost every collectible, starting with other precious metals, moving to fine art and even Pokemon cards can be assessed on these three dimensions.

Gold: A Pricing Perspective

    Gold has a long history in investing, and the best to way to understand where we are right now is to look back at that history. As you look back at up and down years, we can start to make sense of the fundamentals that drive gold prices, as well as the noise added by sentiment and momentum to the pricing process.    

A Usage History

      Gold has been viewed as precious by civilizations going back millennia, with evidence of usage in the form of coins going back to the Lydian civilization, located in Turkey in 600 BC, with the Greeks and the Romans following. In South America, where gold was abundant, it was more likely to have ceremonial or spiritual value, crafted into ornaments, ritual objects and artifacts, and it was only after the Spanish conquistadors arrived that gold acquired monetary status. In Asia, gold coins can be traced back to the Qin dynasty in China in 2500 BC, and to India and South East Asia.

    It is worth noting that for centuries, the issuers (governments and kingdom) of fiat currencies tied them to gold to get skeptical populaces to hold them. In the eighteenth century, this linkage was formalized in the gold standard, where paper currency issuance was backed by holdings in gold, with paper money convertible into gold.  England adopted a de facto bimetallic (silver and gold) standard in the early 1700s, but a miscalculation by Isaac Newton on the silver/gold ratio, where silver was overpriced relative to gold, made it a gold standard. While England did not formally adopt the gold standard until 1818, the United States, at its birth as a country, and eager to have its new currency (the dollar) be accepted, followed England’s model, with a brief break during the civil war in the 1860s. 

    In the second half of the nineteenth century, the gold standard became the base for most major currencies, but two events in the early twentieth century put it to the test. During the First World War, governments in need of money to fund their armies found their hands tied by the constraints of gold, and many were forced to abandon convertibility and the gold standard. The United States stayed with the gold standard into the Great Depression, with some economists blaming the Fed’s actions trying to defend it for worsening the economic collapse. In the face of crisis, individuals rushed to convert dollars to gold, leading to the halting of convertibility and an effective end to a true Gold Standard. After the Second World War, the United States emerged as the economic superpower, and with the Bretton-Woods agreement, the US dollar took the place of gold at the center of the global monetary system, with the dollar convertible to gold at a fixed price. That system held until the early seventies, but broke down as the dollar deflated, and in 1971, it was officially abandoned. While central banks continue to hold gold, the gold standard is now dead, though there are some who seek a return to the system, with its enforced discipline and rigidity.

A Pricing History

    As we noted at the start of this post, gold has had quite a run in 2025, as you can see in the chart below, where we traces it daily price movements during the year:

Through October 24, 2025, gold prices are up 57% for the year, posting significant increases every quarter of the year. To provide perspective on how this year measures up against history, we looked at the percentage change in gold prices every year going back to 1963.

Gold has had its ups and downs over time, with a surge in prices in the late 1970s, with the very best and very worst years in terms of returns occurring within two years of each other; gold prices were up 133% in 1979 and down 32.15% in 1981. Inflation was the culprit, and while we will take a closer look at it in the next section, we also computed the gold price in inflation-adjusted terms in the graph, and on October 24, 2025, that inflation-adjusted price also hit an all time high, using year-end prices. In the graph, you will notice that the gold price was stagnant before 1971, largely because of the convertibility of US dollars into gold. After the Bretton Woods agreement established the US dollar as the international reserve currency, the United States agreed to back it up by agreeing to convert US dollars at $35 an ounce, andgold prices (at least in dollar terms) stayed tethered to that price. In 1971, the United States abandoned that backing, and gold prices have been set by demand and supply since.

Drivers of gold prices

    There is a route that can be used to estimate the "fundamental" value of a commodity by gauging the demand for the commodity (based on its uses) and the supply. While that may work, at least in principle, for industrial commodities, it is tough to put into practice with precious metals in general, and gold because the demand is not driven primarily by practical uses. While gold does not have an intrinsic value, there are at least three factors historically that have influenced the price of gold- inflation, fear of crises and real interest rates.

1. Inflation

    If as is commonly argued, gold is an alternative to paper currency, the price of gold will be determined by how much trust individuals have in paper currency. Thus, it is widely believed that if the value of paper currency is debased by inflation, gold will gain in value. To see if the widely held view of gold as a hedge against inflation has a basis, we looked at changes in gold prices and the inflation rate each year from 1963-2024 in the figure below:

The co-movement of gold and inflation is strongest in the 1970s, a decade where the US economy was plagued by high inflation and the correlation between gold prices and the inflation rate is brought home, when you regress returns on gold against the inflation rate for the entire period:

% Change in Gold price = -0.06 + 3.92 (Inflation rate)  R squared = 18.8%        

While this regression does back the conventional view of gold as an inflation hedge, there are two potential weak spots. 

• The first is that the R-squared is only 19%, suggesting that factors other than inflation have a significant effect on gold prices. 
• The second is that removing the 1970s essentially removes much of the significance from this regression. In fact, while the large move in gold prices in the 1970s can be explained by unexpectedly high inflation during the decade, the rise of gold prices between 2001 and 2012 cannot be attributed to inflation. 

To get a cleaner look at the interaction between gold and inflation, we looked at the percentage change in gold prices, by decade, and contrasted it with the returns on stocks, bills, bonds and real estate in the table below:

Gold has three standout decades - 1971-1980, 2001-2010 and the last five years (2021-2025), with unexpectedly high inflation being the driver of returns in the first and third instances. Gold's surge in the 2001 to 2010 time period can be attributed partially to the 2008 crisis, but gold had several good years leading into the crisis. If there is one finding that we can glean from this data, gold is more a hedge against extreme (and unexpected) movements in inflation and does not really provide much protection against smaller inflation changes.

2. Fear of Crises

    Through the centuries, gold has been the safe haven for investors fleeing a crisis. Thus, as investor fears ebb and flow, gold prices should go up and down. To test this effect, we used two forward-looking measures of investor fears – the default spread on a Baa-rated bond and the implied equity risk premium (which is a forward looking premium, computed based upon stock prices and expected cash flows). As investor fears increase, you should expect to see these risk premiums in both the equity and the bond market increase, and gold to rise in concurrence. The figure below summarizes the risk premiums in financial markets (bond default spreads and equity risk premiums) and gold returns each year from 1963 to 2024:

While the relationship is harder to decipher than the one with inflation, higher equity risk premiums correlate with higher gold prices, but only barely. Again, regressing annual returns on gold against these two measures separately, we get:

% Change in Gold Price = -0.13 + 5.21 (ERP)                             R squared = 5.02%

% Change in Gold Price = 0.13 -1.32 (Baa Rate - T.Bond Rate)     R squared = 0.20%

These regressions suggest little or no relationship between bond default spreads and gold prices, but a modest positive relationship, albeit one with substantial noise, between gold prices and equity risk premiums. Thus, gold prices seem to move more with fear in the equity markets than with concerns in the bond market, with every 1% increase in the equity risk premium translating into an increase of 5.21% in gold prices. As with inflation, though, gold's protective role in crises seems to be greatest during potentially catastrophic economic events, giving it the patina as a crisis hedge.

3. Real interest rates

    One of the costs of holding gold is that while you hold it, you lose the return you could have made investing it in a financial asset, dividends on stocks and coupons on bonds. The magnitude of this opportunity cost is captured by the real interest rate, with higher real interest rates translating into much higher opportunity costs and thus lower prices for gold. The real interest rate can be measured directly used the inflation indexed treasury bond (TIPs) rate or indirectly by netting out the expected inflation from a nominal risk free (or close to risk free) rate. The figure below summarizes real interest rates and gold price changes on a year-by-year basis from 1963 to 2023:

Note that the TIPs rate is available only for the two decades and that the real interest rate is computed as the difference between the ten-year US treasury bond rate in that year and the realized inflation rate (rather than the expected inflation rate). Regressing changes in gold prices against the real interest rate yields the following:

% Change in Gold price = 0.18 – 4.69 (T.Bond Rate - Inflation Rate)        R Squared =21.9%

High real interest rates are negative for gold prices and low real interest rates, or negative real interest rates, push gold prices higher.

The Bottom line

    Gold is often touted as a hedge against inflation and crises, but the evidence from history is nuanced. With inflation, it is a better hedge against unexpected inflation than expected inflation, and even with unexpected inflation, only for increases that put inflation above normal bounds. In short, it is a hedge against hyper inflation. With crises as well, the evidence is mixed, since gold prices are, for the most part, unaffected by movements in equity and bond risk measures that fall within historical bounds, but increase during risk events that are uncommon and potentially catastrophic. Investors who add gold to their portfolios because of the protection it offers should recognize it more akin to buying insurance against extreme events, and more useful if the bulk of their wealth is in financial assets.

Is gold expensive, correctly priced or cheap?

    Knowing that gold prices move with inflation, equity risk premiums and real interest rates is useful, but it still does not help us answer the fundamental question of whether gold prices today are too high or low. Can you price gold against other investments or itself? The answer is yes, though the results are often noisy.

A. Against inflation

In companion papers, Erb and Harvey examined the relationship between gold prices and inflation. In these papers, the price of gold is related to the CPI index and a ratio of gold prices to the CPI index is computed. In the first of these papers, they argued that in the very long term, gold prices increase at roughly the inflation rate, but in the second, they do question that hypothesis. We try to replicate their findings and we use the US Department of Labor CPI index for all items (and all urban consumers) set to a base of 100 in 1982-84, but with data going back to 1947. The level of the index in December 2023 was 308.742. Dividing the gold price of $4118/oz on October 24, 2025, by the CPI index level of 324.80, on that day, yields a value of 17.81. To get a measure of whether that number is high or low, we computed it every year going back to 1963 in the figure below

The median value is 2.93 for the 1963-2024 period and 3.77 for the 1971-2024 period. Thus, based purely on the comparison of the current measure of the Gold/CPI ratio to the historical medians does miss the fact that lower interest rates and inflation in the last decade may be skewing the statistics. Consequently, we regressed the Gold/CPI index against equity risk premiums and real interest rates and while real interest rates seem to have little effect on the Gold/CPI ratio, there is strong evidence that it moves with the ERP, increasing (decreasing) as the ERP increases (decreases):

Gold Price/ CPI = -1.79 + 123.56 (ERP)              R Squared = 47.7%

The implied equity risk premium for the S&P 500 at the start of October 2025 was 4.03%, and plugging that value into the gold/CPI regression yields the following:

Gold/CPI (given ERP of 4.03% on 10/24/25) = -1.79+ 123.56 (.0403) = 3.19

Put simply, gold looks overpriced in October 2025, even after correcting for changing equity risk premiums.

B. Against other precious metals

There is another way that you can frame the relative value of gold and that is against other precious metals. For instance, you can price gold, relative to silver, and make a judgment on whether it is cheap or expensive (on a relative basis). At the end of October 2025, the gold price was $4118/oz and the silver price was $47.80/oz, yielding a ratio of 84.73 for gold to silver prices (4118/47.80). To get a measure of where this number stands in a historical context, we looked at the ratio of gold prices to silver prices from 1963 to 2025 in the figure below

The median value of 57.09 over the 1963-2024 period would suggest that gold is overpriced, relative to silver. Given that gold and silver move together more often than they move in opposite directions, we are not sure that this relationship can be mined to address the question of whether gold is fairly priced today, but it can still be the basis for trading across precious metals.

The Bottom Line

    The historical data yields two conclusions, albeit at odds with each other. If you believe that history is your best guide for the future and that mean reversion will win out, it is undeniable that gold is overpriced against almost every metric it is usually priced against. In fact, you could argue that the rise of gold prices in the last decade is unprecedented since it has not been accompanied by raging inflation or by big market crises (though there have been economic crises).  The counter is that using historical data as a guide, gold has been overpriced over the last decade, a period over which its price has increased almost four fold, from $1060/oz at the end of 2015 to $4,118 on October 24, 2025. When an investment stays overpriced for that long, it is legitimate to question whether the pricing metric is flawed, and whether there a structural shift has occurred that has shifted the distribution. In the case of gold, priced on demand and supply, that shift has to be almost entirely on the demand side, since the stock of gold has continued to expand at a slow, but steady pace, during the period, and here are some of the possible reasons:

1. More pathways to buying/holding gold: For centuries, extending into the last century, the only way to invest in gold was to hold it in its physical form, with all of the limitations on making fractional investments and the added transactions/storage costs. The rise of Gold ETFs has reduced or removed both constraints allowing more investors entree into the gold market.
2. Mistrust of central banks: Investments in financial assets (stocks and bonds) are a reflection of the trust  investors have in central banks and governments, working to preserve the buying power of the currencies that they issue. In the aftermath of central banking activism in the post-2008 period, that trust in central banks and governments has depleted, at least for a segment of the population, leading to a shift on their part to gold (and bitcoin).
3. Slippage of the US dollar: In the aftermath of Bretton Woods, the world adopted the US dollar as a global base currency, with a tether remaining to gold. During that period, central banks held gold, as backup for their currencies, though individuals were restricted or denied the ability to convert currency to gold. Even after the US removed its last formal connection to the gold standard in 1971, the strength of the dollar and the centrality of the US economy allowed investors to use the US dollar as a safe haven currency, as a substitute for gold. It is undeniable that the US economy and dollar have been under stress for the last decade or more, with the ratings downgrade for the US being only a manifestation of these stresses. With no other global currency ready (yet) to take the place of the dollar, you can argue that gold is once again asserting its role as safe haven, and that the rise in its price reflects that status.
4. The Trump effect: While the first two factors have been in play for decades, this year has seen unusual turmoil, as tariff threats and economic wars threaten to unravel an economic world order that has governed markets and economies for much of the last century. While there are some who will welcome that development, it is not clear what the replacement will be, and the possibility of a catastrophic outcome is perhaps greater than it was a year or two ago, and this too is a positive for gold prices.

For much of the last century, investors who held gold in their portfolios tended to be a subset of the market, older and more concerned about catastrophes than the rest of us, but it is undeniable that this group now is both larger and drawing in some who would have historically pushed it away. 

Investment Consequences

    With that long lead in, every investor is faced with the question of whether gold fits into their investment portfolios, and the reason for holding it. There are four pathways that an investor can follow with gold, and without any judgment attached, here they are, with the trade offs involved:

1. Gold as a core investment: There are some investors who have built their portfolios, with gold as a central component, representing a significant portion of their holdings.  
• The trade off: Looking at the last forty years of returns on different investment classes, you can see why making an argument for holding gold as your core investment is so difficult to justify. Gold, with its annual compounded return of 5.35% between 1984 and 2024, would have significantly underperformed an investment in US stocks, that earned a compounded return of 11.38%, a difference that translates into a significant shortfall in ending portfolio value for gold investors; investing in US stocks in 1984 would have generated almost ten times as high an ending value in 2024, as investing an equivalent amount in gold in 1984.
  
  
  
  
  
  In fact, gold has also been a more risky investment, on a stand alone basis, than stocks with a higher standard deviation in annual returns. Does that make gold investors irrational? Not necessarily, because they may define risk in terms of best case and worst case outcomes, and while stock prices, at least in their perspective, have no lower bound, gold has a lower bound value, at least based on history.
• The draw: For investors who have a deep attachment to gold combined with a distrust of financial assets, governments and central banks, the net effect of holding a portfolio dominated by gold is that it improves their odds of passing the sleep test, i.e., they don't lose sleep wondering how their portfolios are doing. In short, they are willing to accept lower compounded annual returns over the long term in return for the security of holding an investment that they view as timeless.
• The choices: Gold's standing comes from its long history as a collectible, but it is not the only collectible. Through time, investors have also put their money in precious gems and other metals (silver, platinum), art and collectibles. In fact, some of the rise in cryptos (currencies, tokens and assets) can be attributed to a subset of (mostly younger) investors, who share the distrust of governments and central banks with gold investors, deciding to use bitcoin as an alternative to gold.
2. Gold as insurance: For investors with the bulk of their portfolios in financial assets (stocks and bonds), gold holdings can help insure their portfolios, at least partially, against inflation and market/economic crises.
• The trade off: As we noted earlier in the post, gold has been only a weak hedge against inflation and market crises that fall within normal bounds, but has done much better as a edge against hyperinflation and catastrophic market/economic risks. Adding gold to a financial asset dominated portfolio can provide insurance against the latter, but only if held in large enough quantity to make a difference; given the history of stock and gold returns, a gold holding that is 5% of your portfolio will not be enough and you will need a holding closer to 15-20%.
• The draw: All investors should be concerned about catastrophic risks, but it is undeniable that this concern varies across investors, with older and more risk averse investors more inclined to have that concern. It is also true that worries about catastrophes vary over time, increasing across all investors in troubled times. 
• The choices: The rise of derivatives markets has increased the choices for investors to buy protection against hyperinflation and catastrophes. Thus, you can use ETFs and options to hedge your portfolio against market collapses, if that is your concern, or shift your investments to other currencies and countries, if your worry is about hyperinflation in the domestic currency.
3. Gold as a trade: In trading, the key to winning is timing, buying when prices are low and selling when they are high, and there are some who make their money on gold by timing its ups and downs well. 
• The trade off: Getting the timing right in trading is easier said that done. While the peaks and bottoms of gold prices are easy to pinpoint in hindsight, it is worth remembering that many investors who became rich riding the gold price boom from 1977-1979 lost it all in next five years. The traders who bought gold in 2022 are riding high, at the moment, after a three-year surge in gold prices, but they too may be looking at disappointment, if they do not cash out at the right time.
• The draw: Trading is a pricing game, and since price is determined more by mood and momentum, success in gold trading comes down to detecting momentum shifts before they occur, and trading on that basis. For some gold traders, this capacity may come from examining charts on gold prices and volume, and for others, it may be in reading the macroeconomic tealeaves, especially on inflation.
• The choices: If trading is your game, the market is ripe with targets, ranging from cryptos in the collective space to meme stocks, and many of these alternatives offer a bigger payoff to trading, since they are more volatile than gold and in some cases, offer more liquidity.
4. Gold as a signal: There are many investors who have no desire to own or or are averse to holding gold in their portfolios, but use gold prices as signals of either hyperinflation or economic catastrophes to structure their portfolios. 
• The trade off: The allure of gold as a signal of inflation and market crises comes from history, where gold prices have tended to rise during periods of high inflation and economic uncertainty. Much of the relationship, though, is contemporaneous, i.e,, gold prices rise in periods when inflation is high and risks surge, and there is only weak evidence of gold prices being a leading indicator of future changes. 
• The draw: Since portfolios composed primarily or entirely of financial assets are badly damaged by unexpected inflation or a market meltdown, having a predictor, even a flawed one, that can give advance warning has big payoffs. In particular, if gold prices rising is a signal that inflation will be higher than expected in the future, you could alter your asset allocation, shifting money from stocks and long terms bonds to short term bills and commercial paper, or even your asset selection, moving money from companies that have little pricing power and significant operating risk to companies with substantial pricing power and predictable earnings streams.
• The choices: Here again, markets offer other choices, with futures markets and forward contracts specifically targeted at predicting inflation or economic and market shocks. Thus, you could use inflation futures to protect against hyper inflation and volatility indicators (like the VIX) to hedge against market crises.

The Bottom Line

    Gold has had a good run this year, and I will not begrudge those who got into it early. Some undoubtedly just got lucky to be at the right place at the right time, but some were prescient in detecting a shift in the market vibe, especially in 2025. The truth is that the market for gold has been and always will be a niche market, drawing a subset of investors, but that niche shrinks and expands over time. When the world is stable and times are good, the niche is composed almost entirely of true believers, a mix of conspiracy theorists and doomsday cultists who believe that fiat currencies are more paper than money and that financial asset markets are designed to enrich insiders. In scarier times, the niche expands, drawing in investors who normally invest in stocks and bonds, but decide, either because of distrust of central banks or perceived market bubbles, that they need the safety of gold. While I do not have a ledger listing everyone holding gold in October 2025, I will wager that it includes names that you would normally expect to see in the list. After all, if Jamie Dimon and Ray Dalio actually mean what they say about markets being a bubble, would it not make sense for them to hold gold?

YouTube Video

Datasets

1. Gold, Bitcoin and Silver prices in 2025
2. Gold, Stocks, Bonds and Real Estate Returns: 1928-2025

A “Fairly Highly Valued” Market: A Fed Chair Opines on Stocks, but should we listen?

     In December 1996, Alan Greenspan used the words "irrational exuberance" to describe the stock market at the time, and those words not only became the title of Robert Shiller's cautionary book on market bubbles, but also the beginnings of the belief that central bankers had the wisdom to be market timers and the power to bend the economy to their views. I think that Greenspan's words seem prophetic, only with the benefit of hindsight, and I believe that central bankers have neither the power nor the tools to move the economy in significant ways. I was reminded of that episode when I read that Jerome Powell, the current Fed chair, had described the market as "fairly highly valued". In market strategy speak, these are words that are at war with each other, since markets can either be “fairly valued” or “highly valued”, but not both, but I don't blame Powell for being evasive. For much of this year, and especially since April, the question that market observers and investors have faced is whether stocks, especially in the United States, are pushing into “bubble” territory and headed for a correction. As someone who buys into the notion that market timing is the impossible dream, you may find it surprising that I think that Powell is  right in his assessment that stocks are richly priced, but that said, I will try to explain why making the leap into concluding that stocks are in a bubble, and acting on that conclusion are much more difficult to do.

Financial Markets in 2025

    It has, to put it mildly, been an interesting year for stocks, as economic headwinds and shocks have mounted, with tariffs, wars and politics all adding to the mix. After a first quarter, where it looked like financial markets would succumb to the pressure of bad news, stock markets have come roaring back, surprising market experts and economists. As a precursor to answering the question of whether stocks are "fairly highly valued" today, let’s take a look at how we got to where we are on September 30, 2025.

Resilient Equities

    We will start with US equities, and while that may seem parochial, it is worth remembering that they represented more than 50% of the total market capitalization of all traded stocks in the world at the start of 2025. In the figure below, we look at the S&P 500 and the NASDAQ, with the former standing in as a rough proxy for large US market cap stocks and the latter for technology companies:

As you can see, US equities were down in the first quarter, but the standardized values indicate that it was much worse for technology companies than for the rest of the market, with the NASDAQ down 21.3% through April 8, the market bottom, while the S&P 500 was down 14.3%. On April 8, the consensus wisdom was that the long-awaited correction was upon us, and that tech stocks would take more of a beating over the rest of the year. The market, of course, decided to upend expectations, as tech came roaring back in the second and third quarters, carrying the market with it. In fact, through the first three quarters, the NASDAQ has reclaimed the lead, up 17.3% so far this year, whereas the S&P 500 is up 13.7%.

    We take a closer and more detailed look at all publicly traded US equities, in the table below, where we break out the year-to-date performance, by sector:

The two best performing sectors in the first three quarters of 2025 have been technology (up $3.93 trillion and 22.4% YTD) and communication services (up $1.29 trillion and 22.3% YTD). There are five sectors which lagged the market, with consumer staples and health care effectively flat for the year, and energy consumer discretionary and real estate up only 4-6% for the year. Financial, industrials and materials, for the most part, matched the overall market in terms of percentage change, and the overall value of US equities increased by $8.3 trillion (13.76%) in the first nine months of 2025. If you puzzled by the outperformance of communication services, it is worth noting that Alphabet and Meta, both of which derive large portions of their revenues from online advertising, are categorized by S&P as communication service companies. These two companies are part of the Mag Seven. and the companies in this grouping have been the engine driving US equities for much of the last decade, leading to talk of a top-heavy market. To assess their contribution to market performance, we looked at  the aggregate market cap of the seven companies, relative to all 5748 traded US equities in 2023, 2024 and 2025 (YTD):

The aggregate market capitalization of the Mag Seven, as a percent of market cap of all traded US companies, has risen from 17.5% at the end of 2022 to 24.6% at the end of 2023 to 29.3% at the end of 2024. Focusing just on 2025, the Mag Seven took a step back in the first quarter, dropping to 26.3% of overall market cap on March 31, 2025, but has made a decisive comeback since, with an increase in market cap of $2.8 trillion in the first nine months of 2025, accounting for 52.4% of the overall increase in market capitalization this year. In fact, the Mag Seven now command 30.35% of the total market capitalization for US equities, a higher percent than at the start of the year. Over the last three years, the Mag Seven alone have accounted for more than half of the increase in market capitalization of all US equities, each year.

    There are other dimensions on which you can slice and dice US equities, and we did a quick run through some of them, by breaking US companies into groupings, based upon characteristics, and examining performance in each one:

1. Small cap versus Large cap: For much of the large century, small cap stocks (especially those in the bottom decile of market capitalization) delivered higher returns than large cap stocks. As I argued in a post from a decade ago, the small cap premium has not just disappeared since the 1980s, but been replaced with a large cap premium. Looking at returns in 2025, broken down by market capitalization at the start of the year, here is what we see:
   
   As you can see, this has been a good year for small cap stocks, with the bottom half of the market seeing a much bigger increase, in percent terms, in market cap than the top half of the market, with much of the outperformance coming in the third quarter.
2. Value versus growth: Another enduring finding from the last century is that low price to book stocks delivered higher returns, after adjusting for risk, than high price to book stocks. While this is often categorized as a value effect, it works only if you accept price to book as a proxy for value, but even that effect has largely been absent in this century. Breaking down stocks based upon price to book ratios at the start of 2025, here is what we get:
   
   While it is too early to celebrate the return of value, in 2025, low price to book stocks have done better than high price to book stocks, but all of the outperformance came in the first quarter of the year.
3. Momentum: Momentum has been a stronger force in markets than either market cap or value, and unlike those two, momentum has not just maintained its edge, but strengthened it over the last few years. Using the price change in 2024 as a proxy for momentum, we broke companies down into deciles and looked at returns in 2025:
   
   After lagging in the first quarter, momentum stocks have made a comeback, with the top half of momentum stocks now leading the bottom half for the year to date in percent change in market capitalization.

In sum, it has been a good year, so far, for US equities, but the gains have been unevenly distributed across the market, and while the first quarter represented a break from the momentum and tech driven market of 2023 and 2024, the second and third quarters saw a return of those forces.

Directionless Treasuries

    While interest rates are always a driver of stock prices, they have played less of a role in driving equity markets in 2025 than in prior years. To see why, take a look at US treasury rates, across maturities, in 2025:

Rates have for the most part are close to where they were at the start of the year, with very little intra-year volatility notwithstanding economic stories about inflation and real growth suggesting bigger moves. The battle between the Trump administration and the Federal Reserve has received a great deal of press attention, but the Fed's inaction for much of the year and lowering of the Fed Funds rate in September seem to have had little or no impact on treasury rates.

    On May 16, 2025, Moody's lowered the ratings for the United States from Aaa to Aa1, joining Fitch and S&P, but again the effect on treasury rates was transient. If you are wondering why this did not translate into an increase in default spreads (and rates), the likely answer is that markets were not surprised by the downgrade, and the best evidence for this is in the 5-year US sovereign CDS spread, a market-set number for default risk (spreads):

As you can see there was a spike in the US sovereign CDS spread this year, but it happened in response to liberation day on March 31, when President Trump announced punishing tariffs on the rest of the world. The Moody's downgrade had little impact on the spread, and even the tariff effect had fully faded by September 30, 2025, with spreads back to where they were at the start of the year (and for much of the last few years).

    Extending the assessment of default spreads to the corporate market, there has been relatively little movement in corporate default spreads in 2025:

Source: FRED

As you can see, the most striking part of the story is that so little has changed over the course of 2025, notwithstanding the spike in spreads in the first week of April, when the tariffs were announced. The Moody's rating and the talk of a recession seem to have done little to supercharge the fear factor, and by extension the spreads. In fact, the only rating that has seen a significant move is in the CCC and below grouping, where spreads are now higher than they were at the start of the year, but still much lower than they were at the end of the first quarter of 2025.

The Rest of the Story

    The economic shocks that hit the US markets, and which US equities and debt shrugged off, for the most part, also reverberated in the rest of the world. The broadest measure of relative performance between US and global equities is the divergence between the S&P 500, a proxy for US equity performance, and the MSCI World index, a stand-in for large cap international stocks, and the results are below:

In the first nine months of 2025, the MSCI global equity index is up 16.6%, about 2.3% more than the S&P 500 over the same period. However, all of this underperformance occurred in the first quarter of 2025, and the S&P 500 has found its winning ways again in the second and third quarters.

    The MSCI index does obscure differences across regions and is titled towards large cap stocks. Consequently, we looked at all publicly traded equities, broken down by regions, with the values in US dollars, and the results so far in 2025 are in the table below:

Global equities were up, in aggregate dollar market capitalization, by 16.8%, and while US equities have underperformed in the first nine months of 2025, with a 13,8% return,  they have rediscovered their mojo in the second and third quarters. The worst performing regions of the world are India, down 3.15%, in US dollar terms, this year, and Africa and the Middle East, up only 2.13%. It is too early to spin stories for why these regions underperformed, but in my data update post from the start of 2025, I pointed to India as the most highly priced market in the world, and this year may reflect a cleaning up. The rest of the world ran ahead of the United States, with some of the additional return coming from a weaker US dollar; the local currency returns in these regions were lower than the returns you see in the table.

US Equities: Overpriced or Underpriced?

    None of the discussion above answers the question that we started this post with, which is whether US equities are overpriced. To make that assessment, there are a variety of metrics that are used, and while all of them are flawed, they vary in terms of what they leave out of the assessment, and the assumptions that underlie them.

At one end of the spectrum, the simplest and most incomplete metric is based purely on price history, with markets that have had extended good runs being viewed as overpriced. A modification is to bring earnings into the assessment, with prices moving disproportionately more than earnings (resulting in higher or lower PE ratios) considered a signal of market mispricing. The third adaptation allows for the returns you can make on alternative investments, in the form of interest rates on treasuries, to make a judgment on market pricing. The final and fullest variant considers growth in the assessment, bringing in both its good side (that it increases earnings in future periods) and its bad side (that it needs a portion of earnings to be reinvested), to make a pricing judgment, but even that variant ignores disruptions that alter market dynamics and risk taking.

1. Rising stock prices

    For some investors, an extended stretch of rising stock prices is, by itself, sufficient reason to conclude that if stocks are doing so well, they must be over priced. This concern will get deeper as the market run gets longer (in terms of time) and steeper (in terms of price rise). Using that framework, you can see why talk of a stock market bubble has built up over the last decade, as stocks keep climbing walls of worry and hitting new highs.  We have had a remarkable bull run in US equities over the last 15 years, with the S&P 500 up over 500% over that period:

Download spreadsheet with historical returns on stocks

In short, the annual return (18.74%) that equity investors have earned over the last fifteen years is significantly higher than the annual return (9.94%) on US equities over the last century. For some, this run-up alone is enough to decide that equities are overpriced and incomplete though this analysis is, you can see its draw for many investors.

2. The Earnings Effect

    Looking at rising stock prices as an indicator of overpricing ignores the reality that markets can sometimes be up strongly, not because of speculation or over pricing, but because of rising earnings. That is the reason that many investors look at market pricing scaled to earnings, or PE ratios, and the graph below captures three variants of the PE ratio - the trailing PE, where you scale market pricing to earnings in the last twelve months, a normalized PE, where you scale the market pricing to average earnings over a longer time period (a decade) and a CAPE or Shiller PE, where you first adjust earnings for inflation and then normalize:

Download historical PE ratios for US equities

All three versions of the PE ratio tell the same story, and in September 2025, all three stood close to all time highs, with the spike at the peak of the dot com boom being the only exception. 

3. The Investing Alternatives

    Stocks that trade at higher multiples of earnings are obviously more expensive than when then trade at lower, but to make a judgment on whether they are overpriced, you still have to compare them to what you can make on alternative investments. For investors in financial assets, those alternative investments are bonds (if you are investing long term) or commercial paper/treasury bills (if you are investing short term). Logically, if these alternatives are yielding low returns, you should be willing to pay a much higher multiples of earnings for risky assets (like stocks). One way in which we can bring in this choice is by flipping the PE ratio (to get the earning to price ratio or earnings yield) and comparing that earning yield to the ten-year treasury bond rate:

Between 2011 and 2020, for instance, the earnings yield was 5.46% but that was much higher than the 10-year treasury bond rate, which averaged 2.15% over that decade. In 2021, the earnings yield dropped to 4.33%, close to a historical low, butt with the treasury bond rate at 1.51%, you could argue that equity investors had nowhere else to go. As treasury bond rates climbed back towards 4% in 2022, stock prices dropped and the earnings yield climbed to 5.72%. In the last three years (2023-25), treasury rates have stayed higher (4% or more), but earnings yields have dropped. In fact, the earnings yield of 4% in September 2025 was 0.16% below the ten-year treasury bond rate, triggering bearish warnings from analysts who use the difference between the earnings yield and the ten-year bond rate as their market timing metric.

4. The Rest of the Story - Cash flows, Growth and Risk

    The earnings yield, in conjunction with the treasury bond rate, is widely used as a market timing tool, but it has two, perhaps fatal, flaws. 

• The first is that it treats stocks as if they were glorified bonds, treating the earnings yield like a coupon, and misses the reason that investors are drawn to equities, which is the potential for growth. Incorporating growth into the analysis has two effects, with the first being that you need reinvestment to grow, and that reinvestment comes out of earnings, and the second being the upside of increasing earnings over time. 
• The second is that the earnings yield/ treasury bond rate differential has had a spotty record timing the market, missing much of the great bull market of the 1980s and 1990s, and clearly not providing much predictive power in the last two years.

There is an approach that you can use to incorporate the growth and cash flow effects into your market analysis. It is to estimate an intrinsic value for the market, where you incorporate the growth and reinvestment effects into expected cash flows, and discount them at a required return that incorporates what you can earn on a riskfree (or close to riskfree) investment and a risk premium for investing in equities.

As you can see, the intrinsic value equation can be used in one of two ways to assess the market. One is to back out an internal rate of return, i.e., a discount rate that yields a present value equal to the market index; netting out the treasury bond rate from this yields an implied equity risk premium for the market. The other is choose an equity risk premium that you believe is reasonable and to value the market. 

    I estimate an implied equity risk premium for the S&P 500 at the start of every month, and use it as my barometer of the market, a receptacle of market hopes and fears, falling in good times and rising during crises. By my computation, the expected return on the index at the end of September 2025 was 8.17%, and with the ten-year treasury rate of 4.16% netted from it yields an implied equity risk premium of 4.01%. The question of whether the market is over or underpriced can be reframed as one about whether the equity risk premium is too low (indicating an overpriced market) or too high (underpriced market). In the figure below, I put the September ERP into perspective by comparing it to implied equity risk premiums for the S&P 500 going back in time:

Download historical implied equity risk premiums for S&P 500

As is often the case with historical comparisons, there is something here for every side of the debate. For those who believe that the market is overpriced, the obvious comparison is to equity risk premiums since the 2008 crisis, and the conclusion would be that the Sept 2025 premium of 4.01% is too low (and stock prices are too high). For those who are more sanguine about the market, the comparison would be to the dot-com boom days, when the implied equity risk premium dipped to 2%, to conclude that this market is not in a bubble. 

    An alternate way to assess market pricing is to assume an equity risk premium and estimate the value of the index using that premium. Thus, if we assume that the average premium  (4.25%) from 1960 to 2024 is a fair premium to the market, and revalue the index, here is what we would get as its value:

Download intrinsic value estimator

With an implied equity risk premium of 4.25%, and a riskfree rate of 4.16%, we get an expected return on stocks of 8.41%, and using analyst estimates of growth in earnings and cash payout ratios that adjust over time to sustainable levels, we arrive at a value for the index of about 5940, 12.6% lower than the index value on September 30, 2025.

The Market Timing Challenge

    It is undeniable that this market is richly priced on every metric, from PE ratios to the earnings yield, net of treasuries, to intrinsic value measures like the equity risk premium, thus providing backing for Powell's assessment of equities as “fairly highly valued”. If you trust in mean reversion to historical averages, it seems reasonable to conclude that stocks are in fact overpriced, and due for a correction. In this section, we will examine why, even if you come to this conclusion, it is difficult to convert it into action.

    Using lawyerly language, let's stipulate that markets are overpriced today, though that overpricing can cover a range of views from the market being a bubble to the markets just being expensive. There are five responses that you can have to this judgment, ranging from least aggressive to most aggressive on the market timing front:

1. Do nothing: The essence of being a non-market timer is that you do not alter any aspect of your portfolio to reflect your market views. Thus, if your preferred allocation mix is 60% in stocks and 40% in your bonds, you stay with that mix, and you not only hold on to your existing investments but you continue to add to them in the same way that you have always done.
2. Hold on to/ build cash holdings: For the most part, you match what you would have done in the do nothing response in terms of overall asset allocation mix and holdings, but you not only put your portfolio additions into cash (treasury bills, money market funds) but when you act, it will be more likely to be selling existing holdings (that you view as over valued) than buying new ones. For many equity mutual fund managers, this statistic (liquid assets and cash as a percent of assets under management) is a rough proxy of how bullish or bearish they are about the overall market.
3. Change asset allocation mix: In this response, you revisit your preferred asset allocation mix, which was set based on your age, cash needs and risk aversion, and alter it to reflect your market timing views. Thus, if you believe that stocks are overpriced, but you view bonds as fairly or even under priced, you will decrease your allocation to the former, and increase your allocation to the latter. If you are constrained to be an all-equity investor, an alternate version will be to reallocate your money from overpriced geographies to underpriced geographies, if the latter exist.
4. Buy protection: With the growth of options and futures markets, you now have ways of protecting your portfolio, without making wrenching changes to your asset allocation or holdings mix. You can buy puts on the index or sell index futures, if you think equities are overpriced, and benefit from the fact that the profits from these positions will offset the losses on your portfolio, if there is a correction. 
5. Make leveraged bets of market correction: The most aggressive way to take advantage of market timing is to make leveraged bets on market corrections, using either derivatives markets (puts or futures) or selling short on either all of the stocks in an index, or a subset of the most overpriced. 

In making this choices, you do have to consider three real world concerns. The first is taxes, with any strategies that requires significant disruptions to existing portfolios, such as changing asset allocation mixes or selling overvalued stocks in the portfolio, creating larger tax bills. The second is transactions costs, which will also be higher for any strategy that is built around more aggressive. The third is timing, which is that even if you are right about the overpricing, being right too early may wipe out the benefits. Speaking of Alan Greenspan's warnings about the dot com bubble, it is worth remembering that his "irrational exuberance" comments were made in 1996, and that the market correction occurred in 2001, and any investor who sold equities right after the comments were made would have underperformed an investor who held on to equities and took the hit from the correction.

    Let's assume that you remove taxes and transactions costs from the assessment to give market timing the best possible pathway to success. To test whether market timing works, you have to create a market timing strategy around your metric of choice, with three steps fleshed out:

1. Choose your pricing metric: As noted in the last section, this can be the percentage increase in stock prices over a recent period, the current or normalized pricing ratio (PE, PBV, EV to EBITDA) or the equity risk premium/intrinsic value for the index.
2. Create your action rule: The action rule specifies the threshold for the chosen metric, where you will act on your market timing. You could, for instance, decide that you will increase your equity exposure if the PE ratio is more than 25% below the median value for the market's PE ratios over the previous 25, 50 or 100 years, and reduce your equity exposure if the PE ratio is more than 25% higher than the median value over the period. Note that  the trade off on setting the threshold is that setting it to a larger value (say 50%) will mean that you time the market less.
3. Choose your market timing response: You specify how much you will increase or decrease your equity exposure in response to the market timing signal. Thus, if you have base asset allocation mix of 60% equities, 40% bonds, you can decide that if your threshold (from step 2) is breached, and the PE ratio drops (increases) by more than 25% below the median, your equity exposure will increase (decrease) to 80% (40%) and your bond exposure reduced (increased) to 20% (60%). The more aggressive you are as a market timer, the greater will be the shift away from your base mix. Thus, you could sell all equities (0% equities, 100% bonds) if the market is overpriced and hold only equities (100% equities, 0% bonds) if the market is underpriced.

To illustrate, let's use the Shiller PE, pick a 25% threshold for market cheapness and  alter your asset allocation mix, which would normally be 60% equity/40% debt to 80% equities/20% debt if the Shiller PE drops 25% below the median (computed over the prior 50 years) and 40% equities/ 60% bonds if it rises 25% above the median. 

Note that the test can easily be varied, using a different metric, different thresholds and different timing responses.

    To avoid being accused of cherry picking the data or deviating from the standard measures of the Shiller PE, I downloaded the raw data on stock returns, bonds and the CAPE each year from 1871-2025 from Shiller's own webpage. To compute the payoff to market timing, I looked at the annual returns to an non-market-timing investor who stayed with a 60% equity/40% bond mix over time and compared it to the returns of a market timer, using the threshold/action strategy described above:

Download CAPE backtesting spreadsheet

Over the last century, this market timing strategy would have reduced your annual returns 0.04% each year, and that is before transactions costs and taxes. If you break this up into two half-centuries, any of the market timing gains were from 1924-1974, and they were mild, and trying to time the market would have reduced your annual returns by 0.41% a year, on average between 1975 and 2024.

    To evaluate whether the payoff would have been different with alternate thresholds, we considered both a much lower threshold (10%) and a much higher one (50%), with the former leading to more market timing actions. We also looked at a more aggressive response, where the equity portion was increased to 100% (instead of 80%) if the market was underpriced and reduced to 0% (instead of 40%) if the market was overpriced. The results are in below:

Download CAPE backtesting spreadsheet

As you can see in this table, there is not a single market timing combination (threshold and action) that would have added to annual returns over the last fifty years. I completely understand that there are other combinations that may work, and you are welcome to download the spreadsheet and try for yourselves, changing the threshold levels for actions and the action itself. You may very well find a combination that adds value but the fact that you have try this hard is indicative of why market timing is a reach.  It is also possible that making these timing judgments only once a year may be getting in the way of them working, but I did use the monthly data that Shiller has accessible, and in my experimenting, there was little that I could see in terms of added value.

Conclusion

    The decision on whether to time markets is a personal one, and while I have concluded it does not work for me, it would be presumptuous to claim that it will not work for you. If you decide that market timing is part of your investment philosophy, though, there are three lessons that I hope that this post has highlighted. The first is that the more incomplete your market timing metrics are, the greater the chance that you will chasing a correction that never happens. It is the reason that you should be skeptical about arguments built around just pricing, PE ratios or earnings yields (relative to treasury bond rates), and even with more complete metrics, you should be scanning the horizon for fundamental changes in the economy and markets that may explain the deviation. The second is that the proof that a metric will work for you will not come from statistical measures (correlations and regressions), but from creating and back-testing an actionable strategy (of buying or selling traded instruments) based on the metric. The third is that even if you do all of this due diligence, market timing is noisy and flawed, and paraphrasing another widely used expressions, markets can stay mispriced for longer than you can stay solvent. 

YouTube Video

Datasets

1. Historical returns on stocks, bonds, bills, real estate and gold: 1927 - 2024
2. PE, Normalized PE, Shiller PE and Earnings Yield Data for US Stocks: 1960-2025
3. Shiller data on stock returns, interest rates and CAPE (monthly): 1871-2024 (from Shiller)
4. Implied Equity Risk Premiums for the S&P 500: 1960-2025

Spreadsheets

1. Backtester for CAPE-based market timing strategies
2. Implied equity risk premium calculator 
3. Intrinsic value for the S&P 500