Here’s what we cover in this episode:
💰 Is the Market Overpriced?: understanding valuation risk in large-cap stocks
⚠️ Concentration Danger: how much the “Magnificent Seven” dominate today’s market
📉 Expected Returns Ahead: what long-term projections actually show
📘 Bond Market Realities: why yields look different this time
🧠 Behavioral Blind Spots: the danger of chasing what worked last year
Executive Summary:
However, the valuations of these technology companies are stretched, and S&P 500 index concentration is at its highest level ever. The next 10 years could look very different from the last.
Understanding Market Valuation and Concentration
The US stock market, as measured by the S&P 500 index, is at its second most expensive level in recorded history. The only time the index has been more highly valued is during the dot-com bubble of the late 1990s (we exclude recessionary periods wherein valuations were artificially inflated by severely depressed corporate earnings).
This is an issue because there is a strong statistical relationship between stock valuations and subsequent 10-year returns. The higher the starting valuations, the lower the subsequent returns tend to be.
Comparing the S&P 500 to four other major global market segments (US mid-size stocks, US small stocks, developed international stocks, and emerging market stocks), investors are paying an average of approximately 85% more for US large companies at today’s valuations.
Today’s US market is also exceedingly concentrated. The Magnificent Seven stocks represent about 35% of the S&P 500. If you invest $100 into the S&P 500 today, $35 is weighted in those seven stocks while the other $65 is diversified proportionally across the rest of the index. This level of concentration is the highest ever recorded, surpassing even that of the dot-com bubble. Investors who primarily own US total stock market or S&P 500 index funds in their portfolios may not be as well-diversified as they think. This could lead to unpleasant surprises in the next market downturn.
Valuation vs. Earnings Growth
A key difference between today’s market environment and the dot-com bubble is that US large stocks, and specifically the Magnificent Seven, are extremely profitable. The market is forward looking, so the question is whether today’s high valuations will be justified by future earnings growth.
Expected earnings growth for the S&P 500 over the next three to five years is approximately 12.5% annually. However, the expected growth rates for the other global market segments we mentioned above are similar. When averaging the data for comparison, investors are paying 85% more for US large companies without a corresponding increase in expected earnings growth.
Forecasting Future Returns
Asset valuations at purchase are strongly indicative of 10-year expected returns. Future returns for stocks and bonds are estimated differently:
- Bonds: Expected returns can be derived from the current yield, adjusted for default risk and the potential impact of changing interest rates.
- Stocks: Expected returns can be estimated by combining the earnings yield (the inverse of the Price-to-Earnings ratio), the expected growth rate, and the dividend yield. If the market is very expensive, an adjustment is made to subtract return, assuming the market will eventually revert to valuations more in line with long-term averages.
Analysis of expected returns from various sources1 shows lower expected returns for US large companies compared to their historical average of ~10%.
- US Large Companies: Expected returns average around 4.7%.
- Other Market Segments: All other listed markets, including US value stocks and Developed ex-US markets (like Germany, UK, and Japan), show higher expected returns due to their lower current valuations and similar expected earnings growth.
Bond markets are also offering relatively attractive expected returns:
- Expected returns for different types of bonds (intermediate-term Treasuries, long-term Treasuries, US investment grade corporate bonds) range between 4% and 5%.
- A well-structured bond portfolio, incorporating different Treasury types and private credit, can currently offer a yield-to-maturity close to 5.85%2. This is competitive with, or even higher than expected returns for large US stocks.
The Importance of Diversification and Behavioral Finance
The expected return differentials discussed above highlight the need for investors to use reasonable, conservative numbers in their financial planning.
This market environment highlights the need for diversification. We see many new and prospective client portfolios overly concentrated in US and particularly US large-cap stocks. These stocks are often 90%-95% of the portfolio. You don’t need to completely eliminate that exposure from your portfolio. However, we believe it is advisable to reduce exposure by diversifying into other asset classes and stock market segments.
We recognize investors are often reluctant to diversify away from areas of strong recent performance. This is a major topic in behavioral finance. The human brain tends to “drive in the rearview mirror” when imagining the future. We assume the future will look like the recent past. This doesn’t work well in investing because it ignores the relationship between today’s valuations and future returns.
The main risks of being overly concentrated in expensive stocks are:
- Lower Future Returns (Opportunity Cost): All else equal; more expensive stocks tend to deliver lower future returns.
- Increased Correction Impact: High-flying stocks tend to be hit harder than more reasonably valued stocks during stock market corrections and crashes.
A sound investment strategy should:
- Avoid chasing past performance.
- Stay diversified both globally (developed international markets, emerging markets) and within the US (value stocks, mid-size stocks, small stocks).
- Build portfolios around durable, long-term return drivers: Valuation and Profitability.
- Align portfolio risk and structure with specific personal goals, not media headlines.
The goal of long-term retirement investing is not to swing for grand slams, but rather to achieve consistent, disciplined returns over a long period.
- Vanguard, J.P. Morgan, BlackRock, and Research Affiliates
- As of 11/17/25, assumes a balanced portfolio with 45% in bonds, 30% of the bonds allocated to private debt.
Authors:
Ryan Wyatt, CFP®, CIMA®
Nick Lewandowski, CFA®, CFP®
Resources:
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This communication is provided by Wyze Wealth Advisors LLC, a registered investment adviser. All material is for informational and educational purposes only and should not be considered personalized investment advice or a recommendation regarding any specific security, strategy, or product.
The assumptions and scenarios presented are illustrative and do not reflect actual investment results. Projections are based on current market conditions, which may change. Past performance is not indicative of, and does not guarantee, future results. All investments involve risk, including the potential loss of principal.
Investment decisions should be made based on an individual’s objectives, risk tolerance, time horizon, and financial circumstances. Additional information about our services, fees, and Form ADV Part 2A is available upon request.
