Beyond the Rally: A Deep Dive into Today's Market Risks
- Anibal Hernandez, CFA
- Oct 8
- 5 min read
The Stock Market's Great, But Is It Running on Fumes?
It’s hard to argue with the numbers: the S&P 500 has had a fantastic run, climbing 14% this year and 18% over the last twelve months. But when something looks this good, it’s smart to ask what’s powering the climb.
Right now, stock prices are outpacing the actual profits companies are making. This has pushed the market into expensive territory, and it's worth looking at the risks that aren't getting as much attention.
You're Paying Too Much for Stocks Right Now
Think of the market's Price-to-Earnings (P/E) ratio as its price tag. It tells you how much you're paying for one dollar of a company's profit. Currently, the S&P 500's P/E ratio is 23.7, which is a 40% premium over the 20-year average of 16.9.
Historically, this price tag is in the 98th percentile of all observations over the last two decades. This means valuations are stretched pretty thin. Such a high level has historically been difficult to sustain, suggesting that for stock prices to continue climbing, corporate profits (the "E" in P/E) must grow significantly. But the economic data suggests that profit growth might be hard to come by, and it’s already started to decline this year.
What the market is implying for earnings
Implied earnings growth can be estimated by dividing the P/E ratio by the PEG ratio. Using SPY as the S&P500 market proxy, implied growth is ~9.7%, which sits around the 97th percentile of the last decade—rich by recent history.
Plain English: Today’s price already bakes in strong profit growth. The odds favor disappointment or, at best, a slower upgrade cycle from here.
Reality Check: The Economy vs. The Market
While the market seems optimistic, several real-world indicators are pointing to a slowdown, which could hit the corporate profits needed to support high stock prices.
Consumers are stressed. The University of Michigan Consumer Sentiment Index is near recession-era lows. This isn't just a vague feeling; 44% of people surveyed explicitly said that high prices are eating into their personal finances, the highest reading in a year according to the University of Michigan. When people feel broke, they spend less, and that directly impacts company revenues.
The job market is cooling. The latest ADP labor report showed a weakening job market as private employers shed 32,000 jobs in September. The Wall Street Journal expected an increase of 45,000 jobs in an economist’s poll. This isn't just a headline—it has a direct impact on the bottom line. Over the past two decades, for every 1% increase in unemployment, corporate profits have taken a hit of around $120 billion, according to a study by Green Musa Capital. As companies prepare to release their next quarterly results, their outlook on future earnings and hiring will be critical.
Business costs are rising. It's not just about customers spending less; it's also about companies paying more. For instance, recent increases in H-1B visa fees make hiring skilled talent more expensive. This forces companies into a tough spot: they can either absorb those costs and watch their profit margins shrink, or they can pass them on to you as higher prices, which fuels more inflation.
Policy noise: The Government-Shutdown Effect
A government shutdown isn’t your core bear catalyst. But if it persists, it delays key data releases (jobs, inflation, unemployment)—clouding the near-term outlook and adding short-term volatility to an already uncertain backdrop.
The Fed Trap
The Federal Reserve is currently trying to win a game of economic Jenga after all the easy pieces have already been pulled out. It has to manage its two primary goals—keeping inflation in check and maintaining full employment—which are now in direct conflict.
This situation increases the risk of a policy mistake. The market got excited about recent interest rate cuts, but the reason for the cuts is what matters. The Fed isn't cutting rates because the economy is booming; it's cutting them to try and prevent a recession driven by unemployment. The huge risk is that making money cheaper to borrow could cause the inflation we're all tired of to heat up again, putting even more pressure on consumers.
Where is Inflation?
What could prove this view wrong:
Stronger-than-priced earnings: Broad EPS beats with confident guidance—especially beyond mega-caps—would validate today’s valuations.
Disinflation without growth damage: A quicker slide toward target inflation with resilient employment would lift real incomes and support multiples.
What would validate the bear case:
Earnings misses and negative revisions breadth through the Q3 reporting season and early Q4 guide.
Labor deterioration: A visible uptick in unemployment that flows through to profit pressure (keep that $120B per 1-ppt framework in mind).
Persistent services inflation: If price stickiness keeps the Fed cautious while growth cools, multiple support erodes.
So, What's the Game Plan?
This doesn't mean you should panic, but it's a good time to be cautious. The market is expensive, the consumer is under pressure, and the Fed has very little room for error.
In times of uncertainty like this, it's a good idea to hedge your portfolios. Think of it like buying insurance. Assets like gold, or even volatility indexes (like VXX or UVXY) that often move in the opposite direction of the stock market, are some of the tool’s investors use to protect against a potential downturn. In this environment, a cautious and well-diversified approach is more important than ever.
Will the S&P500 continue to rise over the next 6-12 months?
Yes, the S&P500 will continue to break records
No, the S&P500 will drop
No, the S&P500 will remain flat
Citations:
ADP, "ADP National Employment Report" , September 2025, Private Sector Employment Shed 32,000 Jobs in September; Annual Pay was Up 4.5%
WSJ, October 2025, "U.S. Lost 32,000 Jobs in September, Says Payroll Processor"
U.S. Citizen and Immigration Services, "H-1B Visas FAQ", September 2025 - FAQ
University of Michigan, "Survey of Consumers", September 2025, Consumer Sentiment
SPY Data - October 2025, Koyfin.com
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