When the curtain closed on 2025, investors had every reason to smile. The iconic Dow Jones Industrial Average (^DJI +0.48%), broad-based S&P 500 (^GSPC +0.65%), and growth stock-driven Nasdaq Composite (^IXIC +0.81%) gained 13%, 16%, and 20%, respectively. It marked the third time in nearly a century that the S&P 500 had gained at least 15% for three consecutive years.
This overwhelming optimism on Wall Street has been fueled by the prospect of future interest rate cuts, the rise of artificial intelligence, the advent of quantum computing, and a resilient U.S. economy.
But when things seem too perfect for the stock market is precisely when investors should be concerned.
Image source: Getty Images.
Although no forecasting model, data point, or correlative event can guarantee short-term directional moves in the Dow, S&P 500, and Nasdaq Composite, select models, data points, and events have uncanny track records of foreshadowing what's to come for stocks. One ultra-rare event, which has been observed only three times in 155 years, offers an ominous warning for Wall Street and investors in 2026 (and beyond).
This has only been witnessed three times since January 1871
At any given time, there are headwinds that threaten to upend the stock market. But there's arguably no greater hurdle for Wall Street to overcome than pricey equity valuations.
Value is, itself, a subjective term that's going to vary from one investor to the next. With no ideal blueprint for evaluating public companies, what one investor finds to be pricey might be viewed as a screaming bargain by another. This subjectivity is one of the reasons why short-term directional moves in the Dow, S&P 500, and Nasdaq Composite are so unpredictable.
However, one historically accurate valuation tool, which has been back-tested 155 years, has done a phenomenal job of cutting through this subjectivity and providing investors with apples-to-apples valuation comparisons for the S&P 500. This time-tested valuation yardstick is the Shiller Price-to-Earnings (P/E) Ratio, which is also known as the cyclically adjusted P/E Ratio, or CAPE Ratio.
S&P 500 Shiller CAPE Ratio data by YCharts.
Most investors turn to the traditional P/E ratio when evaluating whether a public company is cheap, fairly valued, or pricey. The P/E ratio is arrived at by dividing a company's share price by its trailing 12-month earnings per share (EPS). While this valuation measure works well for mature businesses, it often falls short with growth stocks and loses its usefulness during recessions, when EPS can turn negative.
In comparison, the S&P 500's Shiller P/E Ratio is based on average inflation-adjusted EPS over the previous 10 years. Accounting for a decade's worth of EPS history minimizes the impact of recessions and shock events and ensures that the Shiller P/E remains useful during all economic climates.
Since the beginning of 1871, the Shiller P/E has averaged a multiple of 17.33. However, it's spent most of the last 30 years above this 155-year average. This is the result of the internet breaking down information barriers between Wall Street and Main Street, as well as interest rates hovering at or near historic lows throughout much of the 2010s. In other words, investors were willing to accept more risk and higher valuation premiums.
But based on what history tells us, there comes a point where valuations become too extended.
S&P 500 Shiller PE Ratio hits 2nd highest level in history 🚨 The highest was the Dot Com Bubble 🤯 pic.twitter.com/Lx634H7xKa
-- Barchart (@Barchart) December 28, 2025
As of the closing bell on Jan. 7, the S&P 500's Shiller P/E had a multiple of 40.67, which is within striking distance of the 41.20 high set during the current bull market. It's also only the third time in 155 years that the CAPE Ratio has surpassed 40 during a continuous bull market:
- From January 1999 through September 2000, the Shiller P/E was above 40. In March 2000, shortly after the Shiller P/E peaked at 44.19 in December 1999, the dot-com bubble burst. The S&P 500 and Nasdaq Composite eventually lost 49% and 78% of their respective value on a peak-to-trough basis.
- During the first week of January 2022, the Shiller P/E briefly crested 40. This move above a multiple of 40 was subsequently followed by a nine-month bear market that saw the S&P 500 shed 25% of its value.
- Since October 2025, the S&P 500's Shiller P/E has been vacillating between multiples of 39 and 41.
Although the Shiller P/E isn't a timing tool -- i.e., stocks can remain pricey for many months, if not a couple of years, before a correction takes place -- it does have a flawless track record of foreshadowing significant declines in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite. Historical precedent is quite clear that short-term risk currently outweighs the reward.
Image source: Getty Images.
Time and perspective are investors' most powerful allies
While history doesn't always paint the rosiest picture over short periods, it's a different story altogether when investors take a step back and widen their lens.
Though stock market corrections, bear markets, and even crashes are generally disliked by investors, these are perfectly normal events that essentially represent the price of admission to the world's greatest wealth-creating machine. Historically, the stock market endures a double-digit percentage decline once per year.
However, these declines take on a different meaning if you're an optimistic, long-term-focused investor. While rapid and/or sizable downturns can tug on the heartstrings of investors, they're historically short-lived and represent ideal buying opportunities.
^SPX data by YCharts. S&P 500 return data from Jan. 3, 1950-Jan. 7, 2026.
According to data from Bespoke Investment Group, the 27 S&P 500 bear markets from the beginning of the Great Depression (September 1929) to June 2023 lasted an average of just 286 calendar days, or approximately 9.5 months. Comparatively, the typical S&P 500 bull market during this nearly 94-year period persisted for 1,011 calendar days, or roughly two years and nine months.
Although stock market cycles are inevitable, bull markets last disproportionately longer than bear markets. This means every correction, bear market, and crash serves as a buying opportunity for patient investors.
Regardless of the challenges that await Wall Street in 2026, maintaining an optimistic outlook and perspective will be crucial to long-term success.
