I mostly work from an office in my garden, which provides me with a bit of work life separation and the chance to “commune with nature”.
For most of the year this arrangement works well, I have fans to cool the air, and a heater to warm the office, if required.
However, there are days when it becomes uncomfortable to be outside.Typically this is when the temperature rises to 28c or higher, or drops below 3.0c.
On those days I have to decide whether to stick it out or cut and run.
In the winter I usually tough it out, wrap up, warm put on fingerless gloves and a bobble hat.
However, once the sun gets high enough and shines on the office, I can take off the hat, jumper and gloves and work normally and maybe even end up opening a window.
However the same isn't true for the hottest days in summer.
In fact the insulation in the office can work against me then, trapping in the heat.
Even with the windows and doors open, and the fan on full blast it doesn’t cool down
And on those occasions, I say enough is enough and head back indoors.
Being aware of this, and compensating for the temperature change is key to being comfortable in my office, but can the same be said of the market?
Knowing whether the market is warming up or cooling is important, never more so than at potential inflexion points, when it could boil over or freeze solid.
We haven’t had much experience of the latter in modern times, thanks to government bailouts and quantitative easing.
However, in the 1970s bear markets, and inactivity among investors and traders were commonplace.
What we have seen in the last 20 years are a number of corrections. When the market gets too hot, too quickly and spills over. I am thinking of an unwatched pot of jam, boiling away on the stove, as I write these words.
We are just about to enter earnings season again, so now is the perfect time to try and take the temperature of the market.
Let’s start with a measure that is said to be a favourite of Warren Buffet, perhaps the greatest investor of all time and certainly one of the most consistent and savvy.
Mr Buffest likes to watch the ratio between US GDP and US stock market capitalisation. Something that’s relatively easy to measure today, and back through history.
The post below shows the performance of the ratio using the Wiltshire 5000 index, one of the broadest measures of US equities, in ratio to US GDP.
As you can see the indicator has been on a tear of late, jumping by more than +40.0% since April and moving into uncharted territory.
Source: The Kobeissi Letter
What the indicator measures in the multiple that US equities are on in GDP terms, think of it as a sort national price earnings ratio.
A ratio that has doubled in nine years and is way above the long term average of 85.0, and the Dot.com high of 142.
It's clear that on this basis US equities are overbought. Though of course there is nothing to say that they can't become more overbought yet.
What does the US equity market look like when judged by a more traditional yardstick?
Well if we look at PE ratios we find that the S&P 500 12 month Forward PE ratio sits at 22.20 times above the 5 and 10 year averages for the index, at 19.90 and 18.40 times respectively.
Source: FactSet Research
Some more historical context on the S&P 500 Forward PE ratio and other valuation metrics
Source: JPM AM
What does the price-to-sales data say?
S&P 500 Price to Sales Ratio
Source Mulipl.com
3.18 times is the current Price to Sales ratio for the S&P 500 as a whole. It’s at its highest levels for more than 20 years.
However if we drill down to the S&P 100 index, that figure becomes 6.50 times.
What’s more there are some15 stocks in the top 100, with a price to sales ratio that's greater than 10.0 times, which is seen as a rubicon, that’s not meant to be crossed.
You can see these stocks in the table below.
There are several Mag 7 constituents and AI-related names in this list.
The higher the price to sales and PE ratios are for these stocks, then the more they have to produce, when it comes to earnings, in order to justify investor and trader expectations.
You might say these stocks are being priced for perfection.
S&P 100 Stocks with a Price to Sales ratio > 10.0 times
Source: Darren Sinden/Barchart
It's not just some of the S&P 100 stocks that looked stretched when compared to historical data.
As this chart below shows us, not only are the top 10 stocks, in the S&P 500 trading at a multiple of their long term average PE ratios, so are the remainder of the index constituents.
Source: JPM AM
So what comes next?
The charts below shine a light on the relationship between forward PE ratios and future returns, within the S&P 500, over 1 and 5 year periods.
The current situation is highlighted on each chart, by the red diamond.
Though the charts may look complicated, the message they have to tell is pretty straight forward.
High forward PE ratios are closely associated with lower forward returns, over both time frames.
Forward PE vs Future Returns in the S&P 500
Source: JPM AM
And that makes sense really because high PEs tell you that investors are paying more to own companies' income streams . And there has to be a limit to just how far that envelope can be pushed.
A limit on how much a company can grow sales, increase margins, cut costs, and innovate on its products and services.
Of course, in the long term, AI may help businesses exceed what's currently possible, but even with the emergence of AI Agents, that still feels some time away .
JP Morgan (JPM US ), and some other major US banks kick earnings season off on 15/07/2025.
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