Recently, the US stock market has exhibited a strange phenomenon—valuation divergence reaching the most extreme levels in the past 20 years.

A leading investment bank's latest research shows that the Nasdaq 100 is trading at a forward P/E ratio of 28, while the S&P 500 is at 22, both breaking through the 75th percentile in history. Such valuation levels have only appeared during two periods: the 2000 dot-com bubble and the 2021 pandemic stimulus period.

But that's not the craziest part.

The equal-weighted S&P 500 has a P/E of only 17, and the S&P MidCap 400 is at just 16—roughly close to the median level over the past 20 years. This creates a striking contrast: the P/E of the market-cap-weighted S&P 500 and the equal-weighted version differ by as much as 5 times, reaching a record high.

A deeper issue lies in the logic behind these numbers. Over the past 10 years, the earnings growth rate for both types of indices has been around 9%, almost flat. However, the market-cap-weighted P/E has surged 40% to 22.4, while the equal-weighted version has only increased 6% to 17. This indicates what? The market's gains are almost entirely driven by mega-tech giants like the "Seven Giants," with contributions from other companies being negligible. The market breadth is extremely narrow, and concentration is terrifying.

Even more concerning is that the current forward P/E of 22 for the S&P 500 is approaching the 2021 historical peak and even nearing the 24 record in 2000. A well-known investment bank strategist bluntly said, "Such high valuations are hard to ignore. Once earnings fail to meet expectations, the downside risk in the stock market will be significant."

Analysts are, of course, very optimistic, predicting a 15.3% earnings growth for the S&P 500 by 2026. But the problem is, such optimistic growth expectations have long been priced into current stock prices.

An investment firm pointed out that this valuation imbalance between market-cap-weighted and equal-weighted indices is "fundamentally unsustainable." They expect 2026 to be a turning point, with market leadership shifting from a few mega-cap stocks to a broader market.

Mid-cap stocks are particularly worth noting. With an expected earnings growth rate of 17.3% and a P/E ratio of only 15.7, this combination is very attractive to institutional funds.

For retail investors, the current advice is clear: don't pile into overvalued large-cap tech stocks. Shift to reasonably valued mid-cap stocks or equal-weighted portfolios to achieve a better risk-reward ratio. The market is never linear; it is cyclical. When extreme phenomena occur, it often signals an impending correction.