Investors have zero complaints about the performance of the S&P 500 (^GSPC 0.30%). In the past 10 years, the widely followed benchmark has produced a total return of 351% (as of Feb. 12). This translates to a stellar annualized gain of 16%, which is significantly higher than the long-term average of 10%.
However, the stock market today is flashing a clear warning to investors. Here's what history says could happen next.
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Investors are sounding the valuation alarm
The cyclically adjusted price-to-earnings ratio, known as the CAPE ratio, is a tool used to gauge the valuation of the market. It looks at the price of the S&P 500 relative to the average of inflation-adjusted net income over the trailing-10-year period. This metric can help investors better assess whether the overall stock market is cheap or expensive.
Right now, it appears to be the latter. The CAPE ratio, which is 40.4, is at its highest level since the dot-com bubble at the turn of the century.
Invesco, a large asset management firm, has conducted research on correlation data that shows what might happen in the future. According to the analysis, when the CAPE ratio is above 40, as it is today, average annualized returns over the next decade will be flat or slightly negative. If this ends up happening, it would be a major downturn from what we've seen in the last 10 years.
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Key Data Points
Should investors put money to work?
The smartest investors will use this data to help figure out how or when to allocate capital. Perhaps the best thing to do is wait on the sidelines until the CAPE ratio comes down, right?
That line of thinking makes sense, but I believe investors should still put money to work. The stock market in 2026 is structurally different than in decades past.
We've seen the rise of dominant technology companies represent a bigger share of the market's value. These businesses possess wide economic moats, have popular products and services, generate robust free cash flows, and are still growing.
Additionally, passive investing surpassed active strategies in terms of assets in 2023. This introduces tremendous buying power to equity markets.
There's also fiscal and monetary policy to consider. Expanding federal debt levels and ongoing growth in money supply pump more liquidity into the system, which benefits financial assets.
These three powerful trends don't appear to be letting up.
Investors who decide to buy an S&P 500 exchange-traded fund today are making the right choice. And if you're able to add more savings regularly, known as dollar-cost averaging, there are significant long-term financial benefits.
