Over its entire history, the S&P 500 (^GSPC 1.52%) has put together an average yearly return of about 10%. Of course, some years are much better than that. And there are some years when investors post losses.
The market has performed exceptionally well in the past decade, well ahead of its historical track record. Since mid-December 2015, the widely followed benchmark of 500 large and profitable U.S. businesses has produced a total return of 290% (as of Dec. 17), amounting to a compound annual rate of 14.6%.
This year has been very volatile, but the S&P 500 currently trades not too far off of its record high, as it's on pace to finish 2025 with another double-digit gain.
But perhaps it's time to adopt a cautious view. The stock market is flashing a warning sign to investors.
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Valuation is a critical component of the investing process
After such an impressive performance, it might come as no surprise that the S&P 500 trades at a historically expensive valuation. The cyclically adjusted price-to-earnings or CAPE ratio is a widely used metric to assess this valuation. According to data provided by the measure's co-creator, Professor Robert Shiller of Yale University, the CAPE ratio currently sits near 40. Shiller's raw data goes back all the way to 1871. And since then, the CAPE ratio has been more expensive only during the dot-com bubble period that occurred in 1999 and 2000.
Generally speaking, a higher valuation implies that market participants have elevated expectations for company performance. And it introduces greater risk should businesses not live up to those expectations.
Research from asset management firm Invesco indicates that when the CAPE ratio is around 40, on average the S&P 500 will produce a low-single-digit negative annualized total return over the following 10 years. This doesn't instill confidence among investors looking to allocate capital for the long term. On the flip side, when the CAPE ratio is near 20, the S&P 500 has a good shot at generating its long-run yearly average of 10%.
Besides what historical valuation data shows, there's another obvious factor to consider. There are worries that we are currently in a market bubble that's being driven by the ongoing artificial intelligence (AI) boom. The "Magnificent Seven" tech stocks represent about one-third of the S&P 500's market cap, and they have had a major influence on the benchmark's performance. What's more, AI spending has added 1.1% to GDP growth in the first half of 2025, according to JPMorgan Asset Management. Any hint of a slowdown could lead to widespread fears that pressure stock prices.
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Key Data Points
Investors should still be optimistic about the stock market's long-term prospects
You're probably thinking that putting money to work right now is a mistake, since the CAPE ratio clearly indicates that forward returns will be wildly disappointing. That perspective is justified. However, investors should remain optimistic.
The market is just different these days. The companies leading the charge are dominant technology enterprises with wide economic moats, global operations, mission-critical products and services, sizable free cash flows, and very scalable business models. A valid argument can be made that they deserve higher valuations.
Moreover, assets under management in passive investment vehicles exceeded those in active funds in the U.S. at the end of 2023, so there is a lot of money coming from retail investors, creating more demand to buy the most valuable stocks. This has been spurred by fee-free trading and a proliferation of low-cost index funds and exchange-traded funds.
We also have to think about fiscal and monetary policy. Historically low interest rates throughout much of the past decade, coupled with an ever-expanding federal debt balance and money supply, have led to constant currency debasement. This will likely keep leading to higher asset prices.
Despite what the CAPE ratio says, I believe these factors will continue to have a profound positive impact on the stock market's performance in 2026 and beyond. The best thing to do is invest early and often and let compounding take over.
