18 Aug 18th August 2025

Index Movement Last Week

S&P500	+1.0%
Nasdaq	+0.4%
Aussie ASX200	+1.5%

This week I’m fed up with reading things like “the stock market is overvalued” or “we are in a bubble” or any other rubbish like that.

Anyone saying these things doesn’t understand how indexes are calculated and what makes up the index.

Here is their argument – the S&P500 is trading at 22x next years earnings. That is the same forward PE it got to in 1999 at the peak of the Tech bull market. Therefore, just because 22 was the peak once before it must also be the peak this time.

Here is why they have it all wrong

First, the constituents of the index in 1999 were mainly industrials and finance with just a very few tech companies, like IBM. Today the index is mainly tech with a few industrials and finance.

Tech companies rightly trade on higher PEs because never before has an industry operated on such high margins and experienced such high growth.

Even at this most basic level of thinking we can see why just because a 22 PE marked the top then, it does not mean it will mark the top now – because the index itself is different.

Second – we can take this a step further. When I first wrote this piece I wrote a long explanation of the theory and maths to get to the following, then I deleted it all because it is boring and I think you guys just want the answer.

The shortened version is you can take the forward PE of the big tech names, compare to the index, work out the difference then apply their index weighting to that difference and eventually subtract it from the 22 PE I have been talking about.

In laymans terms, I am saying, AI is the big driving force of this bull run. The maths above is an attempt to take out the “AI Premium”. It is a bit like saying, where would we be without AI?

The answer is a forward PE of 19. Which is very acceptable and far from overvalued. It is just fairly valued compared to history and we know comparing to history is not fair becuase of the premium Tech companies are afforded to the PE.

Which brings me to my conclusion. Yes, at the headline level the S&P looks expensive compared to history. But dig a little deeper and it is far from overvalued. What it also means is outside the big AI tech names, companies still have a lot of room to head higher, which itself will likely propel the index to higher levels and of course higher PEs with it.

Big Tech does make up a masssive portion of the index. The top 8 names have a bigger weighting in the index (37%) than the entire weighting of the bottom 7 SECTORS! If something were to happen to them, such as when the Chinese Deepseek model was announced then we could see these names fall which will lead to a moderate fall in the index, but as all the other companies in the index are not overvalued, any fall is not likely to be large or last long.

Tariffs

The inflation report this week confused me. The narrative heading into this report was that if tariff costs weren’t showing evidence of leaking into broader inflation, it would give the Fed room to cut rates in September given rising concerns over the labor market. But this report didn’t exactly show that.

The effects of tariffs appeared to decelerate not accelerate. As for the spillover to broader inflation, that showed an increase for the second straight month.

This report appeared to show the opposite of a scenario where a surge in tariff costs isn’t spread broadly; non-tariff costs accelerated, and tariff related costs didn’t. In other words, this report suggested broad inflation pressure rather than narrow inflation pressure. 48% of the CPI index rose at an annualised pace of >4% in July, which is the second-broadest reading of inflation pressure since 2023.

This is all taking place in the context of YoY core inflation picking up from its three-month stint at +2.8% YoY from March-May to +3.1% YoY now. Regardless of whether core inflation is being driven by tariffs or other factors, getting to 2% for Core CPI by year end looks unlikely.

That begs the question of why the Fed has pivoted so hard towards easing as they approach a fourth consecutive year of above target inflation. If tariff-driven inflation narrowed with little evidence of broadening, the impulse to ignore it would be understandable, but this report didn’t show that.

Regardless, market pricing for a rate cut in September increased to 96% and equity markets rallied following the report and through the day.

Which is what confuses me. Every way I look at this report I see inflation pressures increasing again and with a still strong labor market I would expect to see odds for a rate cut decrease. But the market disagrees. I am missing something…….but for the life of me I cannot work out what it is. Any help would be appreciated.

Warning

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