For most of the past four years, Wall Street has rewarded optimists handsomely. Since the bottom of the 2022 bear market, the timeless Dow Jones Industrial Average (^DJI -1.09%)reference S&P500 (^GSPC -1.82%)and powered by technology Nasdaq Composite (^IXIC -2.86%) gained 82%, 115% and 154% respectively.
The evolution of artificial intelligence (AI) and the continued construction of AI infrastructure have done the heavy lifting. But don’t overlook record IPOs and S&P 500 stock buybacks as catalysts, either.
But when things seem too good to be true on Wall Street, they often are.
Image source: Getty Images.
While the Dow, S&P 500, and Nasdaq Composite have a rich history of rising over several decades, their performance becomes much murkier when examined over shorter periods. Currently, we’re seeing the stock market do something for only the third time in 28 years – and from what history tells us, the next change in direction for stocks could be shocking.
This has only happened three times in the history of the stock market.
To preface the discussion that follows, nothing that has happened in the past can ever guarantee the future of the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite. However, more often than not, past events have a way of foreshadowing the future, which is why history can be a valuable lesson for those who are willing to listen.
For example, history has shown that taking outsized risks, in the face of a rapid increase 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 proven price-to-earnings (P/E) ratio when evaluating individual companies or the market as a whole. 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 in the market as a whole.
While the traditional P/E ratio is calculated using earnings over the past 12 months, the Shiller P/E ratio is based on inflation-adjusted average earnings over the following decade. Although the former can be disrupted by profits turning negative during recessions, the latter remains useful in all economic climates.
Shiller’s PE ratio on the verge of breaking its Dot Com bubble all-time high šØ š¤Æ š https://t.co/CtCmSgWnLt
ā Bar Chart (@Barchart) July 11, 2026
The Shiller P/E, introduced by economists in 1988, was backtested until the early 1870s. Over nearly 156 years, its average is a multiple of 17.44. As of the October 26 close, it stood at 40.66, 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 exceeds 40, the stock market is operating on borrowed time:
- January 1999 to September 2000: The first time the CAPE ratio exceeded 40 occurred before the dot-com bubble burst in March 2000. Internet-induced euphoria pushed the CAPE ratio to a record high of 44.19 in December 1999. By the fourth quarter of 2002, the dot-com bubble burst had wiped out 49% and 78% of the S&P 500 and the Nasdaq Composite, respectively.
- January 2022: The second time the Shiller P/E of the S&P 500 exceeded 40 was considerably shorter than the first. During the first week of 2022, the CAPE ratio remained above 40, fueled by fiscal stimulus amid the COVID-19 pandemic. The ensuing bear market in 2022 caused a fifth, a quarter and a third of the value of the Dow Jones, S&P 500 and Nasdaq Composite to fall over nine months.
- May 2026 to present: Although the CAPE ratio exceeded 40 last year, it has remained consistently above 40 over the past six months.
What history shows is that premium valuations are not well tolerated on Wall Street. While it’s impossible to predict when the music will stop or what catalyst(s) will swing the market as a whole, the Shiller P/E ratio is a clear indicator of what’s next for stocks.
Image source: Getty Images.
More than a century of historical data encourages optimism
However, the great thing about history is that the outcome can change depending on the investor’s perspective.
To state the obvious, bull markets are not indefinite. At some point, a significant stock market correction, bear market, or crash will occur. Since large declines in stocks are usually emotionally driven, no amount of fiscal or monetary policy maneuvers can prevent them from occurring.
But history also shows that these downturns don’t have to be scary events. Although red arrows can sometimes tug at investors’ heartstrings, historical data indicates that bear markets are often short-lived.
A May 2026 post on social media platform
The current bull market that began on 10/12/22 is now the 9th longest in S&P 500 history, surpassing the 1,324-day bull market that ended on 02/9/1966: https://t.co/4mGsS2t2ft
ā Custom (@bespokeinvest) May 30, 2026
Looking back more than a century produces even more attractive results.
Earlier this year, Crestmont Research updated a dataset that calculates the 20-year rolling total returns, including dividends, of the S&P 500 since 1900. Because the S&P wasn’t created 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 of them generated a positive average annual total return. In other words, if an investor had, hypothetically (since funds tracking the S&P 500 were not traded on US exchanges until 1993), purchased an S&P 500 index fund any time between 1900 and 2006 and held it for 20 years, they would have made money every time!
Whether investors have weathered a recession, a depression, a pandemic, an ongoing war, or a historically expensive stock market, they have always made money if they kept perspective and remained optimistic.
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