For the better part of the last four years, Wall Street has handsomely rewarded optimists. Since the 2022 bear market bottomed, the timeless Dow Jones Industrial Average(^DJI-1.09%), benchmark S&P 500(^GSPC-1.82%), and tech-powered Nasdaq Composite(^IXIC-2.86%) have gained 82%, 115%, and 154%, respectively.
The evolution of artificial intelligence (AI) and the ongoing AI infrastructure build-out have done a lot of the heavy lifting. But don’t overlook record-breaking initial public offerings and S&P 500 share buybacks as catalysts, either.
But when things seem too good to be true on Wall Street, they often are.
While the Dow, S&P 500, and Nasdaq Composite have a rich history of rising over multiple decades, their performance becomes far murkier when examined over shorter time frames. Currently, we’re witnessing the stock market do something for only the third time in 28 years — and based on what history tells us, the next directional shift for stocks could be jarring.
This has happened just three times in the stock market’s storied history
To preface the following discussion, nothing that’s happened in the past can ever guarantee what’s to come for the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite. However, more often than not, past events have a knack for foreshadowing the future, which is why history can be a valuable teacher for those willing to listen.
For instance, history has shown that outsize risk-taking, vis-à-vis a rapid rise in outstanding margin debt, can be problematic for Wall Street. But perhaps the biggest risk to the AI-driven bull market is the meteoric rise in stock valuations.
Most investors rely on the time-tested price-to-earnings (P/E) ratio when evaluating and valuing individual companies or the broader market. But the S&P 500’s Shiller P/E Ratio, also known as the Cyclically Adjusted P/E Ratio (CAPE Ratio), can provide more useful apples-to-apples comparisons of the broader market.
Whereas the traditional P/E ratio is derived using trailing 12-month earnings, the Shiller P/E Ratio is based on average inflation-adjusted earnings over the trailing decade. While the former can be disrupted by earnings turning negative during a recession, the latter remains useful in all economic climates.
https://x.com/Barchart/status/2075785469967630519
The Shiller P/E, introduced by economists in 1988, has been backtested to the early 1870s. Over nearly 156 years, it’s averaged a multiple of 17.44. As of the closing bell on Oct. 26, it clocked in at 40.66, or 133% above its long-term average.
A CAPE Ratio above 40 is exceptionally rare, occurring only three times in history (and all since 1999). History says that when the Shiller P/E Ratio tops 40, the stock market is running on borrowed time:
- January 1999 to September 2000: The first time that the CAPE Ratio exceeded 40 occurred in the lead-up to the bursting of the dot-com bubble in March 2000. Internet-driven euphoria pushed the CAPE Ratio to an all-time high of 44.19 in December 1999. By the fourth quarter of 2002, the bursting of the dot-com bubble had erased 49% and 78% from the S&P 500 and the Nasdaq Composite, respectively.
- January 2022: The second time that the S&P 500’s Shiller P/E topped 40 was considerably shorter than the first. During the first week of 2022, the CAPE Ratio hovered above 40, fueled by fiscal stimulus amid the COVID-19 pandemic. The ensuing 2022 bear market lopped off a fifth, a quarter, and a third of the Dow’s, S&P 500’s, and Nasdaq Composite’s value over nine months.
- May 2026 to present: Although the CAPE Ratio surpassed 40 last year, it’s been consistently above 40 over the last six months.
What history shows is that premium valuations aren’t well tolerated on Wall Street. Though it’s impossible to predict when the music will stop or what catalyst(s) will send the broader market over the edge, the Shiller P/E Ratio makes it crystal clear what comes next for stocks.
More than a century of historical data favors optimism
However, the great thing about history is that the result can change depending on an investor’s perspective.
To state the obvious, bull markets aren’t indefinite. At some point, a meaningful stock market correction, bear market, or crash is going to occur. Since sizable moves lower in equities are commonly driven by emotions, no amount of fiscal or monetary policy maneuvering can prevent them from occurring.
But history also shows that these downturns don’t have to be scary events. While red arrows can occasionally tug on investors’ heartstrings, historical data says that bear markets are often short-lived.
A May 2026 post on social media platform X (formerly Twitter) by Bespoke Investment Group analyzed every S&P 500 bull and bear market since the start of the Great Depression in September 1929. Analysts found that the typical bull market lasts about 3.6 times longer than the average bear market: 1,023 calendar days vs. 286 calendar days.
https://x.com/bespokeinvest/status/2060797543047684574
Looking back more than a century produces even more appealing results.
Earlier this year, Crestmont Research updated a data set that calculates the rolling 20-year total returns, including dividends, of the S&P 500 since 1900. Since the S&P wasn’t incepted until 1923, researchers had to track the performance of its components in other major indexes back to 1900.
Crestmont analyzed 107 rolling 20-year periods (1900-1919, 1901-1920, and so on, through 2006-2025) and found that each one generated a positive average annual total return. In other words, if an investor had, hypothetically (since S&P 500-tracking funds didn’t trade on U.S. exchanges before 1993), purchased an S&P 500 index fund at any point between 1900 and 2006 and held it for 20 years, they would have made money every time!
Regardless of whether investors navigated a recession, depression, pandemic, an ongoing war, or a historically expensive stock market, they’ve always made money if they maintained perspective and remained optimistic.
