Do high valuations cause bear markets?

Investing.com -- High valuations alone do not trigger bear markets, according to Yardeni Research, which argues that economic downturns are the real driver.

In its latest note, the firm wrote: “High valuations don’t cause bear markets. Instead, recessions cause bear markets by depressing both earnings and valuation multiples.”

Yardeni Research added that corrections typically occur “when widely feared recessions cause valuation multiples to fall,” but those multiples tend to “quickly rebound when the expected recession doesn’t happen, allowing earnings to continue growing.”

The S&P 500’s correction earlier this year illustrates the point. The benchmark’s forward price-to-earnings ratio (P/E) dropped from about 22.0 at the start of 2025 to 18.0 on April 8 before rebounding above 22.6 in September.

Yardeni noted that the Magnificent-7 stocks led the move lower, with their forward P/E falling from 31.0 to 22.0, before bouncing back to 30.4.

By historical standards, valuations remain elevated. Yardeni observed that “usually in recessions and bear markets, the forward P/E of the S&P 500 falls into the single digits.”

During the last bear market in 2022, the forward P/E bottomed at 15.1—still high given that the “most widely anticipated recession of all time was a no-show.”

The firm highlighted the concentration of high valuations: in September, 46% of S&P 500 companies had forward P/Es exceeding 20.0, while only 7.8% were under 10.0.

Yardeni added that “the forward P/Es of the S&P 500 Value and Growth indexes are historically high at 18.4 and 28.5,” with spreads between major indexes also at historically wide levels.

Ultimately, Yardeni argued that as long as the economy avoids a downturn, elevated multiples may be “sustainable” because “earnings growth can be expected to justify those valuations.”

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