"Racing ahead" of the Federal Reserve, has the U.S. stock market's rally been overdrawn?

Therefore, Robert Pavlik, Senior Portfolio Manager at Dakota Wealth Management, stated that "the upside driven solely by rate cuts is limited in the short term," and "in an environment of economic cooling, people are a bit nervous about a 20% increase."

Analysts at Societe Generale in France stated in a report that other valuation indicators such as price-to-book ratio and price-to-sales ratio also indicate that U.S. stock valuations are far above historical average levels. For example, the current trading price of U.S. stocks is five times their book value, compared to a long-term average of 2.6 times.

Lower interest rates also mean that future corporate cash flows are more attractive, which typically pushes up valuations. However, according to data from LSEG Datastream, the price-to-earnings ratio of the S&P 500 Index dropped to 15.3 times by the end of 2022, rebounding significantly to 17.3 times by the end of 2023.

Matthew Miskin, Co-Chief Investment Strategist at John Hancock Investment Management, stated: "Prior to this, U.S. stock valuations were quite reasonable. Over the next few years, it will be difficult to replicate the multiple expansion of the past one or two years."

Miskin and others indicated that as the possibility of further valuation increases is limited, earnings and economic growth will become the main drivers of the stock market. According to data from LSEG IBES, earnings of S&P 500 Index constituents are expected to grow by 10.1% in 2024, with a further 15% growth next year. The upcoming third-quarter earnings season starting next month will test valuations.

Meanwhile, there are signs that the Fed's commitment to rate cuts may have already attracted investors early. Jim Reid, Global Head of Macro and Thematic Research at Deutsche Bank, who has been studying data since 1957, stated that while the S&P 500 Index tends to remain flat in the 12 months before a rate cut cycle, this time it has risen by nearly 27%.

Reid stated in the report: "You could argue that part of the potential gains from this 'no recession easing cycle' have been borrowed from the future."

It is certain that many investors are not deterred by high valuations and remain optimistic about U.S. stocks.

Valuation is often a clumsy tool when deciding when to buy or sell stocks—especially considering that momentum can lead the market to continue rising or falling for several months before returning to historical average levels. The expected price-to-earnings ratio of the S&P 500 Index was above 22 times for most of 2020 and 2021, reaching 25 times during the 1999 internet bubble.

Furthermore, rate cuts in a high stock market environment often bode well for the market a year later. Ryan Detrick, Chief Market Strategist at Carson Group, stated that since 1980, the Fed has cut rates when the S&P 500 Index was less than 2% from its historical high point on 20 occasions Detrick stated that the index has always risen after a year, with an average increase of 13.9%.

Analysts at UBS Global Wealth Management stated in a report: "Historically, when the Fed cuts interest rates and the US economy is not in recession, the stock market performs well. We expect this time to be no exception."