Investing in the stock market is the best activity that people can do to generate wealth in the long run. The gains in the past decade, for instance, prove this point. The S&P 500 index (^GSPC +0.50%) has generated a total return of 337% (as of Jan. 22), translating to 15.9% on an annualized basis. It's hard to complain about this.
After such a stellar performance, though, the stock market is flashing a clear warning to investors. Here's what history says could happen in 2026 and beyond.
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Investors should understand the current environment
The CAPE ratio is a popular metric that looks at the level of the S&P 500 relative to its constituents' average inflation-adjusted trailing-10-year earnings. While that's a mouthful, it's just a valuation metric. Right now, it's at 40.4. Only during the dot-com bubble period of 1999 and 2000 was the multiple at a more expensive level than it is today.
Asset manager Invesco has conducted research that indicates there is a strong inverse correlation between the starting CAPE ratio and yearly returns over the next decade. When the CAPE multiple is around its current level, investors should expect the S&P 500 to post returns that decline between 1% and 5% each year. Understanding the current environment might drive excessive pessimism from market participants, forcing them to question if it's a smart idea to put their hard-earned savings to work.
These tailwinds can push the market higher
The best investors take the time to know the backdrop. They also realize that the stock market is structurally different today.
We've seen the rise and dominance of technology companies that seem to constantly be getting bigger. They have all of the favorable qualities you can think of. And they continue to drive investor enthusiasm, which makes sense given that we've never seen businesses this powerful before.
Since the Great Recession, the U.S. and other major economies have generally operated with very loose monetary and fiscal policy. Interest rates are at historically low levels. And debt and money supply keep expanding. As a result, liquidity gets added to the system, supporting higher asset prices.
The market fundamentally changed at the end of 2023. This was the first time in history that money in passive investment vehicles exceeded that in active funds. More capital coming in equates to greater buyer demand, again supporting higher equity prices.
These three tailwinds can ease investor worries a bit about the market's current valuation. The savvy move is still to invest early and often, even though returns going forward might not mimic the past decade.
