Yet pressure from incumbents and newcomers erodes these excess returns, spreading economic benefits more broadly and maintaining earnings growth on a stable, long-term path, as the graph illustrates.
Applying the Gordon growth model and assuming corporate earnings growth is limited to 6%-7% due to competition’s enduring role, one perspective holds that the S&P 500’s current PE ratio of 29.5 times already incorporates positive elements such as elevated returns on equity (ROEs), increased reinvestment rates and reduced hurdle rates.
A counterview suggests that powerful barriers are shielding major tech firms — which account for over 30% of the index’s weight — from typical competitive pressures. These include widening economic moats via acquisitions that eliminate rivals, user lock-in through network effects and platform control, and dominance in AI backed by vast proprietary data and computing power.
Reality check
A 2021 literature review by Jack Salmon analysing 40 empirical studies from 2010 to 2020 provides strong evidence that higher public debt levels are linked to reduced economic growth. This relationship often plays out through “crowding out” effects, where government borrowing vies with private sector capital needs, driving up interest rates and stifling investment, innovation and productivity.
The US gross federal debt stands at 119% of GDP — its highest level — and is projected to keep rising, undermining the nation’s capacity for growth and debt reduction. Unlike the post-World War 2 era, when the US escaped high debt through demographic advantages and intentional interest rate suppression, today’s challenges include an ageing population, escalating healthcare expenses, ongoing primary deficits and greater dependence on foreign investors for debt financing.
Moreover, headwinds to consumer demand reminiscent of those before the Great Depression are re-emerging, such as heightened inequality and a growing disconnect between wages and productivity gains. Boosted by stimulus measures and market surges, the top 1% now controls over 30% of household wealth — a concentration last seen before the depression. Similarly, today’s tech boom (echoing the 1920s electrification surge) is propelling productivity without corresponding wage increases, which is weakening consumer demand.
In light of these insights investors in the S&P 500 should exercise caution. With valuations stretched well beyond historical norms (average PE of 17.8 times since 1932), persistent structural risks like soaring debt, inequality and competitive distortions could precipitate sharp corrections or prolonged underperformance, mirroring past bubbles that ended in severe downturns. Diversification, vigilant monitoring of economic indicators and a focus on fundamentals are essential to navigate this precarious environment.
Markets can defy gravity for years but not forever. The S&P 500’s lofty level assumes today’s exceptional conditions will persist. History warns they won’t. Diversify, stay vigilant and remember: in markets, reversion to the mean is inevitable.
Seymour is portfolio manager at Northstar Asset Management.
