Us stocks have fallen sharply recently, but this should come as no surprise to anyone. The valuations of many stocks are already at historic highs. Now, as interest rates rise, most of the stock market is at risk of a revaluation.

One of the important reasons why U. S. stocks have risen sharply before is that low interest rates support high valuations. Interest rates have risen sharply in recent weeks. This makes stocks more expensive compared with bond yields. If stock valuations need to be readjusted for this change in interest rates, it means that U. S. stocks are likely to sell off more sharply, falling by more than 20%.

The price-to-earnings ratio of the S & P 500 has risen to an all-time high since it hit bottom in March 2020. In fact, this is the highest level since the late 1990s, and the S & P 500 is now trading at about 22 times its 12-month expected earnings of $176.03. This is the highest level of forward yield since the early 2000s.

Us stock valuations are extremely high when valuing the S & P 500 based on earnings returns relative to 10-year break-even inflation expectations. The current spread between the two is 2.5 per cent, with a 200-day moving average of 2.8 per cent, compared with a historical average of 4.24 per cent since 1997, meaning higher interest rates on 10-year Treasuries and 10-year TIPS could hurt stocks and trigger a massive revision in valuations.

Over the past five years, the average spread between the s & p 500 and 10-year break-even inflation expectations has been about 3.9 per cent. Assuming that spreads rise to their historical average of 3.9 per cent, the S & P 500's earnings yield will fall back to about 6 per cent. Based on expected earnings of $176.03, that means the S & P 500 will be trading at a price-to-earnings ratio of around 16.5. As a result, the index could fall to about 3000 points, a drop of about 27%.

Valuations of technology stocks have expanded sharply over the past 12 months, so they have been potentially hit hardest at a time of rising interest rates. With its strong and steady growth rate, technology stocks have become the best choice for investors to put their money.

For example,Amazon(AMZN.US) trades at 3.2 times its 12-month expected sales, at the upper end of its historical range and well above its historical average of about 2 times. The price of NVIDIA Corp (NVDA.US) also climbed to about 45 times expected 12-month earnings, at the top of its five-year range.

Bank stocks, by contrast, have recently become one of the biggest winners. In the long run, they are expected to be beneficiaries. The rise in interest rates at the long end of the yield curve has greatly deepened the steepness of the yield curve. This helps banks to increase their net interest income, thereby boosting profits.

JPMorgan Chase & Co(JPM.US),Bank of America CorporationStocks such as BAC.US are not cheap after a big rally, but they will no doubt become more attractive in a broader stock market correction, especially if rising interest rates are accompanied by continued economic growth.

After a sustained rally over the past 12 months, a correction in the market is actually healthy. Predicting a correction in the stock market will not be easy, but as things stand, the combination of rising interest rates and high valuations seems about to set off a storm.