Bond markets have rapidly repriced near-term expectations for U.S. inflation in response to surging commodity prices. The implied 1-year breakeven inflation rate is now above 5% for the first time since 2022.   

Elevated bond market-implied inflation expectations may present a problem for U.S. large cap equity valuations because the market is priced to expect very little inflation at this time. The S&P 500 is still trading over 20X times trailing earnings. On average historically, P/E managed to average a level over 20X only when inflation was below 3.5%. The S&P 500 P/E averaged closer to 17X when inflation was between 3.5-4%, and that average dropped to merely 12.8X when inflation accelerated past 5%, historically.