Every Tuesday afternoon we publish a collection of topics and give our expert opinion about the Equity Markets.

This year has seen U.S. equity markets soaring. Major indexes like the S&P 500 and Nasdaq Composite have been setting record highs, buoyed by a resilient economy and hopes for more accommodative monetary policy. Such milestones reflect robust market sentiment but they also raise questions about valuations. ABSI this week will answer the question on every investor's lips: is this market rally sustainable? 

One noteworthy aspect of this rally is its narrow breadth. A handful of mega-cap technology companies have driven a disproportionate share of gains, leading to rich overall market valuations. While strong earnings and innovations justify some premium, today’s elevated price-to-earnings ratios suggest investors are paying up for quality and growth potential. It appears that supply and demand dynamics in the stock market have shifted in ways that favor higher valuations for the most sought-after companies.

S&P 500 P/E Ratio

Source: Multpl

One key factor often overlooked in the discussion of record market highs is the shrinking supply of publicly traded stocks. The U.S. stock market simply has fewer companies available to invest in than it did a few decades ago. A wave of mergers, acquisitions, and fewer IPOs has steadily reduced the count of publicly listed firms. The number of U.S. publicly traded companies has dropped dramatically – from a peak of about 8,100 in 1996 to roughly 6,100 today. This means investors today have a much smaller pool of stocks to choose from, even as the economy and population have grown.

Several trends have driven this consolidation of equity supply. Many companies now opt to stay private longer, or indefinitely, thanks to abundant venture capital and private equity funding. Others have been acquired or merged, often by larger competitors or private equity buyouts, thus removing them from public markets. Regulatory burdens and the cost of being a public company have also dissuaded some businesses from listing. The result is that while U.S. stock indexes hit new highs, they do so with far fewer individual stocks. In practical terms, a scarcity of public companies means that the most profitable, innovative, and dominant firms attract disproportionate investor demand. A limited supply of shares, coupled with ample investor appetite, naturally pushes prices up.

U.S. Stock Market Concentration

Source: J.P. Morgan

Supply is just one side of the equation. On the demand side, another trend emerges: the amount of money sloshing around in the financial system is historically high. One way to measure this is the M2 money supply, which includes cash, checking deposits, savings, and other easily accessible funds. During COVID-19, extraordinary fiscal and monetary stimulus caused M2 to explode upward, and after a brief dip in 2022–2023, it’s rising again. As of mid-2025, U.S. M2 money supply has surpassed a record ~$22 trillion. Year-over-year M2 growth is running above 4%, the fastest in nearly three years. In short, liquidity is abundant once again.

This abundance of money has significant implications for stocks. Higher M2 means investors have more cash that needs a home, and much of it finds its way into financial assets like equities. During 2020–2021, we saw a dramatic influx of money that fueled asset price inflation, not just in stocks, but also in real estate, crypto, and other markets. Even when the Federal Reserve tightened policy in 2022–2023 (causing a temporary dip in M2), the overall level of liquidity remained very high by historical standards. Now, with M2 expanding again, demand for investments is robust. Investors, both retail and institutional, are eager to put their cash to work in assets that offer growth or yield. U.S. stocks, especially shares of high-quality companies, are a prime target. Strong demand chasing a limited supply of stocks tends to drive prices up, all else equal. This helps explain why stock indexes can keep hitting new highs even in a moderately growing economy; there’s a lot of money competing for a finite number of equity investment opportunities.

U.S. M2 Money Supply

Source: FRED

When you combine record-high demand (liquidity) with a low supply of stocks, you get a classic recipe for higher prices. In equity markets, this manifests as investors paying a higher valuation premium for ownership in the most coveted companies. This doesn’t necessarily mean a crash is imminent; rather, it may indicate a new equilibrium under different supply-demand conditions.

Investors may need to adjust expectations and strategies in this environment. Gone are the days when one could easily find dozens of underpriced gems in a broad market of thousands of public companies. Today, much of the market’s value is concentrated in a smaller roster of firms, and these firms command premium pricing. For example, the S&P 500’s forward price-to-earnings ratio is elevated, and market veterans note echoes of past periods of exuberance. But unlike the dot-com era, many of today’s high-fliers have substantial earnings and cash flows.

The U.S. equity landscape today features record-high market indexes, a diminished roster of publicly traded companies, and a money supply near all-time highs. This unique mix means that investors may have to get used to paying higher premiums for great companies. When a lot of cash is chasing a limited set of quality assets, prices naturally climb. While this can be unnerving for value-conscious investors, it reflects a fundamental reality of supply and demand. Until we see a meaningful change in either the supply of investment-worthy stocks or the demand (liquidity) flooding markets, elevated valuations could very well be the norm. In practical terms, that means recalibrating what is considered a “reasonable” price for strong businesses, staying selective, and always remembering that in a high-premium world, quality matters more than ever. Investors might not love paying up, but in today’s market, “expensive” stocks can stay expensive – and even become more so.

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