The market is not in a bubble, but there are certainly bubbles within the market. A “bubble” occurs when speculation drives prices far beyond what fundamentals can justify. We can gauge this by looking at valuation metrics like price-to-earnings (P/E) ratios and comparing them to historical averages. From there, we can infer whether rising prices are being fueled by fundamentals or pure speculation.
Bubble location matters
Before judging whether “the market” is in a bubble, investors must first define which markets matter to them. For passive index investors like us, that usually means the S&P 500 (large companies), S&P 400 (mid-sized companies), and S&P 600 (small companies). This brings us back to the idea that there are “bubbles in the market,” but not necessarily “a market in a bubble.” For our purposes, we’ll assert that the S&P 500—the proxy for “the market”—is not in a bubble.
Quantum computing and AI-related energy stocks, on the other hand, are certainly exhibiting bubble-like behavior. However, none of these stocks are key components in any of the market indexes we invest in. Therefore, we expect that these specific bubbles can burst without materially affecting the value of a diversified portfolio.
Comparing Nvidia to Cisco
Let’s compare today’s setup to the most famous modern bubble: the Dot-Com Boom. One of the era’s highest-flying stocks was Cisco (CSCO), then a major S&P 500 heavyweight. Between 1995 and 2000, Cisco’s stock rose more than 1,800%. The problem? Its earnings never justified the move. Cisco ended 1999 trading at a P/E ratio of 200—meaning investors paid $200 for every $1 in earnings. Historically, technology stocks have traded for an average of 24× earnings, so Cisco was nearly 1,000% more expensive than normal.
Now compare that to today’s AI poster child, Nvidia (NVDA). Like Cisco in the 1990s, Nvidia’s stock has surged—up more than 1,500% in the past three years. But unlike Cisco, Nvidia’s earnings growth supports much of the price increase. Its P/E ratio sits around 52—high, yes, but nowhere near Cisco’s at the peak of the Dot-Com era.
The Dot Com Bubble fits the definition of excess speculation that was detached from market fundamentals. While the market today is not “cheap” — it certainly does not seem detached from market fundamentals. After all, Nvidia’s sales have exploded: revenues have climbed from about $20 billion five years ago to more than $160 billion today. Cisco’s 1990s revenue growth pales in comparison.
It’s also worth remembering that markets spend most of their time being technically “overvalued.” When measured against long-term averages, the S&P 500 rarely trades at “fair value.” Instead, markets cycle through four valuation zones:
- Very undervalued
- Undervalued
- Overvalued
- Very overvalued
“It’s the earnings, stupid”
The market’s usual “overvalued” state stems from a simple fact: stocks tend to rise over time. As prices rise, so do valuations—but often for good reason. Companies innovate, grow earnings, and find new ways to make more money than before. The chart below illustrates that S&P 500 earnings have trended higher for decades, with downturns—like the 1940s, 1970s, and early 2000s—lining up neatly with earnings declines.
As James Carville might say if asked about the stock market: “It’s the earnings, stupid.”
Blue line shows S&P 500 company earnings per share, red line shows S&P 500 price index
So yes, there is certainly speculative froth building in certain corners of the market—but the broader market still reflects real, measurable earnings power. Most of the time, markets trade above their long-term averages because progress itself pushes those averages higher. What matters isn’t whether the market is “cheap” or “expensive” in isolation, but whether prices and earnings remain connected. Right now, they still are—and if anything, there’s a bubble in people calling the market a bubble.
Don’t want to miss anything?
Subscribe to our monthly newsletter for market insights.
