Valuation soars to the "sky," will the peace agreement be the trigger for the "good news fully priced in" in the US stock market?

As almost all major valuation models for U.S. stocks issue warnings of "serious overvaluation," analysts are now beginning to worry that positive news regarding a Russia-Ukraine peace agreement may trigger a "buy the rumor, sell the news" scenario.

According to CCTV News, on the afternoon of August 18, local time, Trump met with Zelensky at the White House and stated that if all goes well, they would hold a trilateral meeting involving the U.S., Russia, and Ukraine. He believes that Russian President Putin wants the war to end, and the U.S. will work with Ukraine and other parties to ensure lasting peace.

The market is concerned that once the expectations for a peace agreement are fully digested, there will be a lack of new upward momentum. As demonstrated during the COVID-19 pandemic, the core driving force behind market rebounds was the massive liquidity injected by the Federal Reserve, rather than the health of the economy itself. Therefore, the core question now is, after the geopolitical card is played, what can support the currently overvalued levels?

Almost all major valuation models for U.S. stocks currently issue warnings of "serious overvaluation." Data as of June 30 shows that key valuation indicators such as the Buffett Indicator, CAPE ratio, and Price-to-Sales ratio are all exceeding their long-term averages by two to three standard deviations, reaching levels seen during historical bubbles in 1929, 2000, and 2021. Historically, after the market reached these high valuation levels, there was subsequently a significant correction of over 40%.

Record Valuation Levels

Several widely recognized valuation indicators show that the U.S. stock market is not only expensive but has also reached extreme overvaluation levels. According to data from CurrentMarketValuation.com as of June 30, most key models assess the market as "seriously overvalued."

• Buffett Indicator: This indicator measures the ratio of total market capitalization to GDP, currently around 200%, exceeding its long-term average by two standard deviations. Historically, similar levels were only seen at the peak of the internet bubble in 2000 and at the end of 2021, both of which were followed by market corrections of over 40%.

• CAPE Ratio: This ratio currently hovers around 35 times, also above the historical average by two standard deviations. It was previously only reached in 1929 and 2000, both of which ended in market crashes.

• Price-to-Sales Ratio: This indicator has deviated from the trend line by more than three standard deviations, setting a historical extreme. Whether in 2000 or 2021, when this ratio reached such high levels, it was accompanied by severe valuation regression

• Mean Reversion Model: This model compares the S&P 500 index with its inflation-adjusted trend line, showing that the current index is more than three standard deviations above the trend line. The last time this level was reached was at the end of 2021, after which the market fell by 25% in 2022.

Interest Rates and Macroeconomic Headwinds

Even models that are usually tolerant of the stock market in a high-interest-rate environment are flashing red. Against the backdrop of 10-year U.S. Treasury yields exceeding 4%, the interest rate model still determines that U.S. stocks are "overvalued," which means that stocks are not providing enough attractiveness compared to bonds. The only model that has not issued a warning, the Earnings Yield Gap Model, only indicates "reasonable valuation," but this suggests that stocks are not as extremely expensive relative to bonds, rather than being cheap in themselves.

Meanwhile, the macroeconomic environment is deteriorating. The latest Producer Price Index (PPI) report shows that inflationary pressures are hotter than expected, which leaves the Federal Reserve with very limited room to cut interest rates in the short term. Persistently positive real interest rates are quietly dragging down economic growth, and this impact will ultimately transmit to corporate earnings. Once earnings expectations begin to be revised down due to high interest rates and rising costs, the currently high valuations will become even more difficult to sustain.

In addition to traditional risks, cryptocurrency has evolved from a fringe asset to a part of the financial system, constituting a new potential risk point. According to Quoth the Raven analysis, cryptocurrencies like Bitcoin have deeply integrated into the mainstream financial "pipeline system" through channels such as ETFs, 401(k) pension plans, and corporate balance sheets