Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 682

Bleeding air out of the bubble

Equity valuations have compressed by a decent amount over the last 12 months with no broad market crash or even a meaningful correction. It is unusual to see equity multiples move downward with so little market disruption, but it has helped relieve some pressure on the “bubble” debate. Indeed, the S&P 500’s forward price-to-earnings ratio peaked near 23x in October 2025 and now sits around 19x. The Magnificent Seven have seen a more pronounced de-rating, from around 33x to 23x – a 10-point compression – while the rest of the index (ex-Mag 7) has fallen from approximately 20x to 18x.

Normally, a price-earnings compression of this size comes with significant stock volatility; the last comparable episode of P/E decline, for example, was triggered by the Liberation Day shock, which induced a rapid and painful equity correction. Typically, when valuations are elevated, the market eventually pops; if it doesn’t, investors worry about future risks. However, this de-rating has been driven by earnings surging well beyond prices – earnings have been the driver bleeding some air out of the bubble.

The de-rating process has been remarkably measured: volatility has flared around discrete events rather than reflecting a broad loss of confidence. It has also been fundamental and bottom-up. The market has not been repriced wholesale; average pairwise correlation among S&P 500 stocks is around 10%, close to its lowest level since 2020, suggesting that individual names are being repriced rather than the index being degraded indiscriminately.

The more extreme devaluation of the Magnificent Seven is not surprising to us. We wrote a number of months ago about how the Mag 7 were at risk of becoming less magnificent as a group compared to other parts of the market. But even independent of their underperformance, investors have seen most equity markets (including non-U.S. equities) get notably cheaper, which indicates a universal paradox: the bull market continues with solid momentum, yet equities trade at more attractive valuations.

So why has the market de-rated so calmly? We see five key reasons.

1. Rates. Higher discount rates usually result in lower P/E multiples. The 10-year Treasury yield is the relevant observable benchmark: it has risen roughly 84 basis points since late October 2025, almost entirely through real yields rather than unanchored inflation expectations. As we discussed recently, real rates deserve close attention and further yield increases could threaten equities.

But for now, the rise in yields arguably reflects a reversion toward higher-trend nominal GDP growth rather than a warning sign. That’s a very different backdrop from 2022, when rising rates brought painful losses for growth stocks. Here, growth in expected earnings has provided a cushion, and equities have taken it in stride, even while narrowing price-earnings multiples.

2. Net capital supply. Equity buybacks, a massive tailwind in prior years for stocks, are showing signs of stalling, as new buyback announcements have peaked and rolled over. The hyperscalers in particular are increasingly funding the AI buildout through new equity and debt issuance rather than repurchasing stock. This not only increases incremental equity supply, but it also adds growing corporate debt supply for investors to assess. More capital competing for a finite pool of demand makes for a buyer’s market, and buyers will usually want better valuations: higher yields and lower P/Es. In essence, investors require a higher risk premium. This is the supply side of the same reset.

3. Capital intensity. A meaningful cohort of the market has shifted from low-capex, high-margin, intellectual-property and digital models toward hard assets, high capital expenditure and, in some cases, higher debt. Capital intensity (defined as capex to sales ratio) in the S&P 500, excluding financials, is now above its dot-com-era peak. The long-term relationship is powerful: more capital-intensive, lower-margin businesses generally command lower multiples. That helps explain why the Magnificent Seven have seen the sharpest de-rating. The shift also changes the quality and duration of the index’s cash flows.

4. Earnings sustainability and cyclicality. Strong earnings do not resolve the question of how long they will last. Some investors see this earnings phase as a sugar high – the “pig going through the python” – while others see growing evidence that it is more sustainable, with replacement cycles tied to AI. Demand for AI validation remains high, but the concern remains fair: investors will not put a high multiple on an earnings base they fear might be temporary.

Market composition matters, too. When cyclicals are the winners, they are historically considered value stocks, so as value and cyclical companies become a larger part of the index by market value, their typically lower P/E multiples exert more influence on the broader market. Historically, value has also tended to outperform growth after Fed hiking cycles.

5. Geopolitics. While the hardest to quantify, there is little doubt that geopolitical uncertainties have grown in recent years. Unresolved trade tensions and broader global uncertainty add a risk premium to markets. They can affect costs, demand and the reliability of earnings forecasts, while higher commodity prices can put pressure on inflation and bond yields. Geopolitical risk, therefore, reinforces the other four drivers in terms of increasing risk premium and downwardly impacting valuations.

Together, these drivers have allowed a relatively calm valuation de-rating while investors have continued to enjoy healthy year-to-date gains. We will be paying ongoing attention to these dynamics, but, for now, we continue to believe leaning into risk assets remains the right position. The orderly release of valuation pressure has reduced one major source of concern, allowing us to focus more closely on the earnings and cash flows needed to sustain further gains.

 

Jeff Blazek Co-Chief Investment Officer, Multi-Asset Strategies, and Amr Hanafy is a Research Analyst at Neuberger, a sponsor of Firstlinks. This material is provided for general informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. You should consult your accountant, tax adviser and/or attorney for advice concerning your own circumstances.

For more articles and papers from Neuberger, click here.

 

  •   30 September 2026
  • 2
  •      
  •   
2 Comments
Cynical Investor
October 04, 2026

It’s a major driver mate. Superficial analysis like in the article doesn’t realise that the P/E derate is basically one company booking earnings while another company capitalises the expense onto the balance sheet. Usually when one company sells a product to another it is revenue for one and an expense for the other. Not in AI fairy land.

 

Leave a Comment:

RELATED ARTICLES

What if Trump is right?

Expensive market valuations may make sense

The wisdom of buying absurdly expensive stocks (or not!)

banner

Most viewed in recent weeks

It’s time for LICs to die

A high-profile dividend cut and a prominent fund manager’s apology have reignited a long-running debate. If investors can access similar exposures more cheaply and efficiently elsewhere, what exactly is keeping LICs alive?

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

The new capital gains tax trap for your portfolio

Investors have long accepted one portfolio rule without much question. A major tax shift could change that calculation entirely, forcing difficult trade-offs between risk, discipline and an overlooked cost lurking beneath.

The retirement scorecard: how many of these questions can you answer?

From the maths of retirement, estimating spending and picking the right asset allocation to survive a poor decade, here are the questions every retiree – current or future – should be able to answer for themselves.

How the typical Australian Family could save $844,350 in taxes

The value of a testamentary trust is not determined by wealth alone. Depending on circumstances, it can reduce the tax burden on inherited income, create efficiencies and help build intergenerational wealth.

The housing slide could become a crash

House prices are sliding across Australia, yet the most dangerous ingredient for a housing crash is still missing. If job losses surge amid growing economic risks, today's correction could become a historic property downturn.

Latest Updates

Retirement

The retirement scorecard: how many of these questions can you answer?

From the maths of retirement, estimating spending and picking the right asset allocation to survive a poor decade, here are the questions every retiree – current or future – should be able to answer for themselves.

2026 is not 1999

The US market looks eerily similar to the dot-com era with soaring AI spending and tech giants dominating returns. But one difference separates today’s boom from the dot-com bubble and it could determine what happens next.

Planning

Taxing time for trusts

Trusts are facing a shake-up, but an overhaul may not be necessary. Families can explore restructuring strategies that preserve succession and the asset protection benefits that have made these structures valuable.

Economy

Why the US economy is stronger than you might think

War, inflation and higher rates were expected to derail America. But has the market got it wrong? Three forces are driving the economy beyond expectations, revealing implications for stock prices and portfolio positioning.

Gold

How much trust is in your portfolio?

Everyone talks about diversifying assets. Far fewer think about diversifying trust. As inflation, debt and market assumptions collide, the question is whether portfolios need greater protection from unexpected outcomes.

Retirement

Retirement in reality - 7 months in

Seven months into retirement, I'm still uncovering surprises. This month was spent reflecting on the slow pace of health change, the myth of neatly scheduled part-time work and the unexpected persistence of retirement guilt.

The new geography of technology leadership

The next chapter of technology may not belong to the companies or business models many expect. As the landscape shifts, some opportunities are emerging in places that remain surprisingly overlooked by global markets.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.