S&P 500 Sees Nearly Zero Gains in Five Months: Valuation Drops to 18.5 Times, Are US Stocks Getting Cheaper?

TradingKey - The S&P 500 Index has experienced multiple rounds of noticeable volatility over the past five months, only to end up nearly back where it started. The index closed at 7,580.07 points on October 30, compared with 7,580.06 points on May 29, a difference of just 0.01 points. On the surface, the broader U.S. stock market appears to have stalled, but valuations, capital flows, and the rally's internal structure have undergone significant changes.

The S&P 500's forward price-to-earnings ratio currently stands at around 18.5 times, falling to its lowest level since April 2025, which is not only below its five-year average of 20.14 times, but also below its 10-year average of 19.55 times. Notably, this valuation contraction was not primarily driven by a decline in the index, but rather by corporate earnings estimates rising faster than stock price gains. While the S&P 500 has still posted double-digit gains since 2026, its forward P/E ratio has dropped by approximately 17% year-to-date.

US Stock Valuations Passively Decline as Earnings Growth Outpaces Index Gains

The price-to-earnings ratio is determined jointly by stock prices and expected earnings. Even without a noticeable decline in the index, valuation multiples will contract as long as analysts continue to revise corporate profit forecasts upward. This has been precisely the case for the S&P 500 over the past several months: the index has traded sideways near highs while forward 12-month earnings expectations have continued to climb, making the broader market appear cheaper than at the start of the year.

According to FactSet data, roughly 60% of S&P 500 constituents have reported third-quarter results, with blended earnings up more than 30% year over year; fourth-quarter earnings are projected to grow by about 25%, and could rise by more than 16% in 2027. If these projections materialize, the current forward P/E multiple of 18.5 times is not extreme.

However, this earnings season has also revealed a concern: earnings per share reported by S&P 500 constituents have exceeded market expectations by an average of only about 1.9%, significantly below the five-year average surprise of roughly 7.5%. This indicates that while corporate profits continue to grow, the positive surprises delivered to the market are diminishing.

With index valuations still near 18 to 19 times, merely meeting expectations may not be enough to fuel a new rally. Particularly for highly valued AI and Big Tech companies, investors are not only demanding sustained revenue growth, but also looking for capital expenditures to actually translate into profits and free cash flow.

AI Investment Returns Face Scrutiny as Capital Starts Leaving Few Leaders

Previously, the primary drivers of the S&P 500's rally were mega-cap tech companies and semiconductor firms. As cloud computing companies continue to ramp up investments in data centers, chips, and power infrastructure, the market has begun to recalculate the payback periods for these projects.

Corporate earnings remain robust, but this has not fully dispelled investor concerns over AI spending. Some tech companies are increasingly relying on debt or equity financing to support infrastructure expansion. Should financing costs rise, or if AI revenue growth lags behind depreciation and interest expenses, profit margins could face pressure.

These concerns have markedly amplified volatility in tech stocks and capped the performance of the market-cap-weighted S&P 500 Index. However, cooling among tech leaders does not mean all stocks are weakening in tandem. Capital is flowing from previously high-flying AI concept stocks into financials, industrials, energy, and select consumer companies, actually broadening market breadth.

This shift is best reflected in the S&P 500 Equal Weight Index. Over the past five months, the market-cap-weighted S&P 500 Index has been virtually flat, while the equal-weighted index has risen about 4.7%. Because the equal-weighted index assigns roughly equal influence to each constituent, its advance indicates that more mid-sized constituents are participating in the rally.

This divergence indicates that U.S. stocks have not lost growth momentum as a whole, but are instead undergoing an internal rotation. Mega-cap tech stocks have come under pressure, weighing on the market-cap-weighted index dominated by a handful of giants; at the same time, previously lagging sectors have begun to catch up, reducing the market's reliance on individual AI leaders.

From a market structure perspective, a broadening rally is typically healthier than an index driven higher solely by a handful of heavyweight stocks. However, sector rotation may also suggest that investors are lowering their risk appetite and actively trimming their concentrated exposure to high-valuation growth stocks.

Is the S&P 500 Worth Buying After Valuation Decline?

A forward P/E ratio of 18.5 times is below its five- and ten-year averages, making the S&P 500 more attractive than at the start of the year, but a declining valuation does not equate to an imminent rally in the index. Historically, P/E ratios have limited predictive power for short-term market performance; if earnings expectations are revised downward, valuations that currently appear reasonable could rise again.

The next direction for U.S. equities will hinge on two factors: first, whether corporate earnings can maintain double-digit growth in 2027, and second, whether Big Tech's AI investments can deliver adequate returns. If earnings continue to grow and AI capital expenditures gradually translate into cash flow, the S&P 500 is poised to resume its advance from a lower valuation base; if profit forecasts are revised downward, the fact that the index has moved sideways for five months does not mean the correction is over.

Therefore, U.S. equities currently appear to be digesting prior high valuations through earnings growth rather than entering a broadly undervalued phase. The S&P 500 is indeed cheaper than at the beginning of the year, but whether it can translate this valuation advantage into upside potential still requires companies to prove it with actual earnings.