Damodaran noted that 2025 has been a turbulent year for stocks. He said, “Jerome Powell, the current Fed chair, had described the market as ‘fairly highly valued.’ In market strategy speak, these are words that are at war with each other, since markets can either be ‘fairly valued’ or ‘highly valued,’ but not both.” Despite this ambiguity, Damodaran agreed with Powell’s assessment that stocks are richly priced, but cautioned that leaping to the conclusion of an imminent bubble or correction is much more complicated.
“After a first quarter, where it looked like financial markets would succumb to the pressure of bad news, stock markets have come roaring back, surprising market experts and economists,” he said. Notably, the technology-heavy NASDAQ rebounded from a 21.3% drop through April 8 to post a 17.3% gain year-to-date, outpacing the S&P 500’s 13.7%.
The bulk of gains stems from what Damodaran calls the “Mag Seven”, tech and communication giants including Alphabet and Meta, whose combined market capitalization now accounts for over 30% of U.S. equities and contributed more than half the total market value increase this year.
Valuation metrics signal caution
Multiple valuation indicators converge to signal elevated market prices. Damodaran highlighted that all three popular PE ratios, trailing, normalized, and CAPE (Shiller PE), are near all-time highs, barely surpassed only by the dot-com boom peak. He said, “All three versions of the PE ratio tell the same story, and in September 2025, all three stood close to all-time highs.”Looking at expected returns, Damodaran’s calculation of the implied equity risk premium (ERP) for the S&P 500 stands at 4.01%, which is low compared to post-2008 crisis levels and indicative of an overpriced market. Yet, compared to the dot-com bubble era when the ERP dropped to 2%, the current market does not constitute a classic bubble scenario.
5 strategic responses for investors
Recognizing that an “overpriced” market diagnosis does not automatically translate into an actionable strategy, Damodaran offered five measured approaches investors might consider:
Do nothing: Maintain existing portfolio allocations and continue regular investing practices without changes.
Increase cash holdings: Build liquidity by directing new investments to cash-like instruments and consider selling perceived overvalued holdings cautiously.
Change asset allocation: Adjust the mix of stocks and bonds or shift geographic exposures based on valuation differences.
Buy protection: Use derivatives such as puts or futures to hedge portfolio risk without large portfolio disruptions.
Make leveraged bets: Aggressively bet on a market correction through leveraged derivative positions or short selling.
Lessons on market timing
Damodaran’s verdict on timing the market is sober: “Over the last century, this market timing strategy would have reduced your annual returns 0.04% each year, and that is before transaction costs and taxes.” Even more aggressive or more frequent timing schemes failed to deliver positive excess returns in his backtests.
He distills three essential takeaways: first, market timing metrics must be comprehensive and account for fundamental market shifts; second, success demands rigorous backtesting of actionable strategies rather than reliance on statistical correlations; and third, “markets can stay mispriced for longer than you can stay solvent.”
For investors grappling with today’s “fairly highly valued” market, Damodaran stressed that translating a view of overvaluation into successful trades is far from straightforward. For investors, the decision to attempt market timing remains deeply personal, but the professor’s analysis serves as a cautionary reminder that even when stocks look pricey, predicting the timing and extent of a correction is an inherently uncertain endeavor.
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(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of the Economic Times)
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