S&P 500 median forward P/E, 1986-9/30/2016
Source: BofA Merrill Lynch US Equity and US Quant Strategy
But despite the historically high average, "relative to other asset classes, the case for stocks is most compelling versus bonds, where the risk premium remains elevated and the S&P 500 dividend yield trades near a 60-year high versus the 10-year Treasury yield," the note said.
The S&P 500 climbed to all-time highs this summer and has remained within 4 percent of those levels. Over the last 12 months, defensive, high-yielding sectors such as telecommunications and utilities have been among the top performing sectors.
High valuations and high correlations "stem from the same basic uncertainty for stocks because we're in these uncharted waters," Colas said. Investors "don't know what is the right valuation for stocks."
In this environment, investors may need to explore other strategies such as selecting stocks across industry sectors based on factors of market cap size or volatility.
"We do think we're at an important point in the industry. It's not so much about stock picking but understanding your sources of return," Jennifer Bender, director of research for global equity beta solutions at State Street Global Advisors, told CNBC in an interview at the end of September.
That said, some analysts expect S&P 500 earnings per share to return to growth as soon as the third quarter. If that happens, then sector correlations should decline with improving fundamentals. The Federal Reserve is also expected to raise rates in December, taking another step away from very easy monetary policy that has kept interest rates low and stocks elevated.
"Recently we've seen, as interest rates have risen (there's been) more focus on fundamentals," said Brad Neuman, vice president and client investment strategist at Fred Alger Management. He expects the bond-like utilities and consumer staples sectors to give back much of their gains and sectors like consumer discretionary, health care and technology to perform better.
Technology stocks bounced back this summer as most beat earnings expectations.
Correction: This article has been updated to reflect that Neuman is client investment strategist at Fred Alger Management.