Why an Expensive Stock Market Can Keep Rising

A strange thing is happening in the market. Many people feel that the economy is under pressure, yet the United States stock market remains very strong. Household debt reached about \$18.8 trillion in the first quarter of 2026. (1) Inflation was 3.8% over the year to April 2026, with energy prices up 17.9%. (2) The labour market was not collapsing, but it was also not euphoric: the unemployment rate was 4.3%, and employers added 115,000 jobs in April. (3) Initial jobless claims were still low at 211,000 in the week ending 9 May 2026. (4) So the correct question is not, “Why has the market ignored reality?” The better question is, “What forces are keeping money inside the market?”

The stock market is not the economy. The economy is people working, earning wages, paying rent, buying food, repaying debt, and running businesses. The stock market is the price investors are willing to pay for pieces of listed companies. These two things are connected, but they are not the same. A family can feel poorer because food, energy, and debt payments are more expensive, while large listed companies can still make strong profits and attract global capital.

A useful way to see how expensive the market is is the Buffett indicator. This compares the total value of the stock market with the size of the economy. In plain language, it asks: “How much are investors paying for the stock market compared with one year of national economic output?”

The formula is:

\[\text{market value to economic output ratio} = \frac{\text{total stock market value}}{\text{annual economic output}}\]

Using one March 2026 estimate:

\[\$69.15\text{ trillion} \div \$31.57\text{ trillion} = 2.19\]

To turn 2.19 into a percentage:

\[2.19 \times 100 = 219\%\]

That means the total United States stock market was valued at about 219% of annual United States economic output under that calculation. (5) Another current version of the Buffett indicator, using corporate equities divided by gross domestic product, put the figure at 229.5% after the first-quarter 2026 economic output estimate. (6) The exact number depends on the data definition, but the conclusion is the same: the market is expensive by long-term standards.

This does not mean the market must crash tomorrow. Expensive things can become more expensive. A house that is overpriced can still sell for more next year if buyers keep arriving with money. The same is true of shares. Price alone tells us risk is high; it does not tell us the exact date when risk becomes loss.

One important reason the market can stay strong is automatic investing. Millions of workers contribute to retirement accounts every payday. They are not waking up each morning and deciding whether Nvidia, Apple, Microsoft, Amazon, Meta, Tesla, or Alphabet is cheap or expensive. Their money simply goes into retirement funds, index funds, and target-date funds.

An index fund is a fund that copies a market index. It does not try to pick the best shares. It buys the companies in the index according to the index rules. The Standard & Poor’s 500 index gives more weight to larger companies because it is float-adjusted market capitalisation weighted. (7) So when the biggest companies become even bigger, new money going into the index gives them a large share of the next dollar too.

This is why concentration matters. The seven largest technology-related companies known as the Magnificent Seven accounted for 34.8% of the Standard & Poor’s 500 on 12 May 2026. In plain language, if someone put \$100 into a fund that exactly copied that index, about \$34.80 would go into those seven companies. That is not “most” of the money, because most means more than half. But it is still a very large amount for only seven companies out of five hundred. (8)

The calculation is simple:

\[\$100 \times 34.8\% = \$34.80\]

So a broad-looking index can become less broad than people assume. The investor thinks they own “the market”. In reality, a large part of the result depends on a small number of very large companies.

This does not make index investing bad. Low-cost index funds are often sensible for long-term investors. The point is different: index investing changes the plumbing of the market. Money can flow into the largest shares because they are large, not necessarily because they are cheap.

This can support prices during ordinary market weakness. If the market falls, automatic retirement contributions do not immediately stop. Many target-date funds also rebalance. A target-date fund is a retirement fund designed around an expected retirement year. If shares fall and bonds hold up better, the fund may buy shares to restore its target mix. Research on the pandemic period found that target-date funds were a stabilising force in United States equity markets and that these funds made contrarian flows, meaning they bought stocks when stocks had performed badly. (9)

But there is a crucial distinction. Automatic investing can cushion a fall. It cannot repeal the market cycle. A Federal Reserve staff paper on the shift from active to passive investing says the change has increased some risks and reduced others. That is a balanced finding. It does not say passive investing has created a permanent anti-crash machine. (10)

There is also computer-driven trading. Some funds follow price trends. Some reduce risk when volatility rises. Some option-market hedging can force buying in one situation and selling in another. This means algorithms are not simply a friendly safety net. In calm markets, they can help prices recover quickly. In stressed markets, some systematic strategies can amplify volatility. The same Federal Reserve staff paper specifically notes that some passive or systematic strategies, such as leveraged and inverse funds, can amplify market volatility. (10)

The cleanest way to understand this is with a simple image. Imagine a crowded theatre. If a few people walk toward the exit calmly, nothing happens. If many people walk toward the exit at the same time, everyone notices. If the lights flicker, the crowd may speed up. Market structure is similar. Passive money, retirement contributions, target-date funds, hedge funds, option dealers, and risk-control models all interact. Sometimes they absorb stress. Sometimes they transmit stress.

The first major pressure point is bond yields. A bond yield is the annual return an investor expects from lending money through a bond. A United States Treasury bond is money lent to the United States government. It is usually treated as one of the safest assets in the world in nominal terms, meaning the government is expected to pay the dollars it owes. But it is not risk-free in every sense. If inflation is high, the dollars paid back may buy less. If an investor sells the bond before maturity, the price can fall.

Bond yields matter because they compete with shares. If a ten-year Treasury bond yields 3%, many investors may still prefer shares. If it yields 5% or more, the calculation changes. Investors may ask: “Why should I take equity risk if safer bonds already pay me a reasonable return?”

As of 18 May 2026, the ten-year Treasury yield was 4.61%. On 15 May it was 4.59%. That is not yet 6% or 7%, but it is high enough to matter for valuation. Higher yields make future company profits less valuable today because investors can earn more elsewhere. (11)

Here is the plain-language valuation idea. Suppose a company will give you \$100 in the future. If safe bonds offer almost nothing, that future \$100 looks very attractive. If safe bonds offer a decent return, investors demand a lower price for that future \$100. This is called discounting. It means future money is worth less than money today, and the discount rate is the return used to translate future money into today’s value.

The second major pressure point is employment. Automatic retirement investing depends on paychecks. If people are employed, contributions continue. If unemployment rises sharply, contributions slow. Some people may even withdraw money early to pay bills, even if it is tax-inefficient or painful.

At the moment, the official labour data do not show that kind of break. The unemployment rate was 4.3% in April 2026, and initial claims remained low by historical recession standards. But this is exactly why weekly jobless claims are worth watching. A single weekly number does not prove much. A sustained upward trend would matter more. (3, 4)

This is where the market risk becomes more serious. A normal sell-off can be absorbed by automatic buying and rebalancing. A deeper recession is different. If unemployment rises, earnings fall, credit stress increases, and investors need cash at the same time, the market can lose several supports together.

That is why leverage is dangerous. Leverage means using borrowed money or financial products that magnify gains and losses. If an investor has £10,000 and uses leverage to get £30,000 of market exposure, a 10% market fall does not feel like 10%. The exposure falls by £3,000, which is 30% of the investor’s original £10,000 capital.

The formula is:

\[\text{loss on exposure} = \text{market exposure} \times \text{percentage fall}\]

Using the example:

\[£30{,}000 \times 10\% = £3{,}000\]

Then compare that loss with the investor’s own capital:

\[£3{,}000 \div £10{,}000 = 30\%\]

So a 10% market fall can become a 30% loss of capital. This is why leverage can destroy good long-term thinking. The investor may be right over five years but still be forced out in five weeks.

The practical conclusion is not “sell everything”. That is too simplistic. The better conclusion is: know what kind of money is inside the market. Long-term capital can survive volatility. Emergency money should not be in volatile assets. Borrowed money can become a trap. Concentrated index exposure is not the same as full diversification.

The market today is expensive, concentrated, and supported by powerful automatic flows. That combination can keep prices high for longer than sceptics expect. But it also means the market is more dependent on a small group of companies, stable employment, and bond yields not becoming too attractive.

The key lesson is simple enough for a school student to understand: a bridge can carry heavy traffic for a long time, but that does not mean weight no longer matters. The stock market can keep rising while risks build underneath it. The intelligent investor does not need to predict the exact breaking point. The intelligent investor needs to avoid being forced to sell when the bridge starts shaking.

The main point is not fear. The main point is preparation: keep enough cash for real-life needs, avoid excessive leverage, understand what your index funds actually own, and remember that liquidity is most valuable when everyone else suddenly needs it too.

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