A painless reset for equity valuations?

By Joe Aylott, Multi-Asset Strategist

• Elevated valuations do not necessarily lead to market declines. In 2026, strong earnings growth has helped equity valuations fall closer to long-term averages, even as share prices have risen.
• The S&P 500 is now around 16% less expensive in valuation terms than at its October 2025 peak, despite total returns of around 14%.
• We believe investors should look beyond valuations alone. Resilient earnings, continued economic growth and a supportive backdrop continue to underpin our preference for equities over bonds.

Over the past decade, equity market gains have been driven by long-term earnings growth, but also by rising valuations. This has raised concerns that markets have become expensive.

For some, a market correction – a sharp fall in equity prices – appeared to be the most likely route back to more historically typical levels. But this is not the only possible outcome.

Markets do not always need to fall to become less expensive. Valuations can also decline when company earnings grow faster than share prices. 

The earnings effect in practice

This is exactly what we have seen over the course of 2026 so far. S&P 500 valuations have fallen even as equity prices have risen, because company earnings have grown faster than company share prices.

This is reflected in the S&P 500 forward price-to-earnings (P/E) multiple, which compares the index’s current price with the earnings its companies are expected to generate over the next year.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

In October 2025, this forward multiple peaked at 23 times earnings, meaning investors were paying around $23 for every $1 of expected profit. Today – as at 22 September, 2026 – it stands at roughly 19 times earnings (or $19 for every $1 of expected profit). This is the same as the average over the last 10 years, with the 25-year average being 17 times earnings.

Today’s figures show that the index has become about 16% less expensive in valuation terms, despite total returns of 14% since the end of October 2025.

Valuations vary by sector and company, and the decline has been sharper in technology. That particular sector’s forward multiple has fallen from 32 times forward earnings in October 2025 to 21 times forward earnings today, while the sector itself has seen total returns of around 22% since last October.

What valuations can – and cannot – tell investors

Valuations compare an asset’s current price with the profits or cash flows it is expected to generate. They can help investors assess prospective long-term returns, but they cannot reliably predict when markets will rise or fall.

Their usefulness also differs across asset classes. For bonds, starting yields – the annual income offered by bonds relative to their price at the outset – have historically been a relatively strong guide to long-term returns. This is because income typically makes up a large part of bond returns.

For equities, starting valuations also matter. High valuations can weigh on long-term returns because investors are already paying more for future earnings, and more of the expected growth may already be reflected in prices. This leaves less scope for valuations to rise further.

It is also worth noting that valuation is only part of the picture: returns depend on dividends, earnings growth and changes in valuation multiples. 

Why valuation signals alone are not enough

A market can remain expensive (or cheap) relative to historical levels for a long time, and high valuations do not mean a market fall is imminent. This adds to the argument against trying to time the market. There are no guarantees in investing, but investors who try to wait for a particular entry point have historically risked remaining too defensive for too long. We examined this issue in a recent article.

As 2026 has shown, valuations can adjust through stronger earnings rather than through falling prices.

This is why our Anchor framework — part of our Anchor & Cycle investment process — focuses on expected returns rather than valuations alone.

We assess starting valuations alongside expected earnings growth, inflation, interest rates and the wider economic outlook. Together, in our view, these factors provide a more complete view of potential opportunities and risks.

What does this mean for our view on equities?

Our Anchor & Cycle framework has led us to prefer equities to bonds, to varying degrees, since October 2023. We retain that preference today.

The normalisation of valuations does not remove all risks. S&P 500 earnings per share grew by almost 30% year-on-year in the second quarter of 2026, and year-over-year earnings growth has remained in double digits for seven consecutive quarters. It would be unrealistic to expect that pace to continue indefinitely.

However, earnings growth does not need to remain close to 30% for equities to perform strongly. In our view, the key question is whether earnings continue to grow sufficiently to support share prices, rather than whether they maintain the exceptional pace seen recently.

It’s worth noting that our pro-equity view rests on our assessment of the full market and macroeconomic picture, rather than on valuations alone. Resilient corporate earnings, continued economic growth and a relatively benign inflation backdrop support our preference for equities over bonds.

Earlier this year, we reduced the size of our equity overweight as monetary policy became less supportive. This reflected a more measured approach to risk rather than a change in our underlying view.

The experience of 2026 nevertheless provides an important reminder. Elevated valuations do not inevitably end in a correction. When earnings grow faster than prices, markets can potentially become less expensive while continuing to deliver positive returns. So far, the normalisation in equity valuations has occurred through stronger fundamentals, not weaker markets.