The Stock Market Is in Ultra-Rarified Territory and Doing Something for Only the 3rd Time in 154 Years -- and History Is Crystal Clear What Happens Next

Yahoo

4 hours ago

Outsized volatility in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite has investors looking to history for guidance.
An encompassing valuation tool with a perfect track record of predicting the future when back-tested to 1871 offers a warning to Wall Street.
The stock market is a simple numbers game that rewards long-term investors who maintain perspective.
10 stocks we like better than S&P 500 Index ›
There are a lot of ways for investors to grow their wealth, including purchasing Treasury bonds, buying certificates of deposit from their local bank or credit union, acquiring real estate, or investing in commodities such as gold, silver, and oil. But none of these other asset classes has held a candle to the annualized return of stocks over the last century.
However, there's a catch to putting your money to work in the greatest wealth creator on the planet: Stocks are inherently volatile. Although the ageless Dow Jones Industrial Average (DJINDICES: ^DJI), benchmark S&P 500 (SNPINDEX: ^GSPC), and innovation-inspired Nasdaq Composite (NASDAQINDEX: ^IXIC) have all decisively risen over multiple decades, their performance over shorter timelines is no more certain than a coin flip.
Through the first five months of 2025, we've observed the broad-based S&P 500 launch to a fresh record closing high, which was followed by corrections in the Dow Jones and S&P 500 and the first bear market in three years for the Nasdaq Composite. In fact, a one-week period in April produced the fifth-biggest two-day percentage slide for the S&P 500 in 75 years, as well as the largest single-day nominal point gain in the index's history.
When the stock market swings wildly, investors commonly look to history for guidance. Even though no specific data point or event can guarantee with concrete accuracy what's to come next, some of these metrics and events correlate very strongly with directional moves in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite throughout history.
One such ultra-rare indicator, which has surfaced only three times for the S&P 500 when back-tested over the last 154 years, has foreshadowed what happens next for stocks with pristine accuracy.
Historical data has uncovered a number of stock market correlations in recent weeks, many of which point to strong upside for equities over the next year. However, one of the rarest indicators, which is focused on stock valuations, suggests quite the opposite.
To preface the following discussion, "value" is a subjective term. What you perceive as expensive may be viewed as a phenomenal bargain by another investor. Nevertheless, one valuation tool has a knack for cutting through this subjectivity: the S&P 500's Shiller price-to-earnings (P/E) ratio, which is also known as the cyclically adjusted P/E ratio, or CAPE ratio.
The valuation tool investors are probably most comfortable and familiar with is the traditional P/E ratio, which divides a company's share price by its trailing-12-month earnings. While the P/E ratio is a fantastic measuring stick for mature businesses, it often gets tripped up by growth stocks and during periods of economic turbulence (e.g., the COVID-19 pandemic).
In contrast, the Shiller P/E ratio is based on average inflation-adjusted earnings over the previous 10 years. Accounting for a decade's worth of earnings history and adjusting it for inflation offers the most apples-to-apples valuation comparison for investors.
As of the closing bell on June 5, the S&P 500's Shiller P/E clocked in at a multiple of 36.52. For some context, this is more than double its historical average reading of 17.24 and slightly below its peak reading of 38.89 in December 2024 during the current bull market cycle.
When back-tested to January 1871, there have been only three instances where the Shiller P/E has ever neared or surpassed 40:
In December 1999, before the bursting of the dot-com bubble, the Shiller P/E peaked at its all-time high of 44.19.
During the first week of January 2022, immediately prior to the start of the 2022 bear market, the S&P 500's Shiller P/E briefly touched 40.
In recent months, the Shiller P/E has prominently vacillated between 35 and almost 39.
The reason these specific figures are mentioned has to do with the correlation between Shiller P/E readings above 30 and the subsequent performance of equities.
Including the above three instances, there have been six total occurrences since 1871 where the Shiller P/E has surpassed 30 and maintained this level for at least two months. Eventually (the keyword!), the Dow, S&P 500, and/or Nasdaq Composite lost between 20% and 89% of their value following these peaks.
Even though the Shiller P/E is in no way a timing tool, it has foreshadowed the inability of the stock market to sustain an extended valuation over a long period, 100% of the time, spanning 154 years. Based on the current multiple of 36.52, significant downside in the major stock indexes is the expectation.
Considering how strongly the Dow Jones, S&P 500, and Nasdaq Composite have bounced back from their mini-crash in April, the prospect of a meaningful pullback in all three indexes probably isn't what investors want to hear. Thankfully, history is a two-sided and completely disproportionate coin that overwhelmingly favors optimistic, long-term investors.
As much as we might dislike the unpredictability and velocity of moves lower in one or more of Wall Street's major stock indexes, corrections, bear markets, and even crashes are perfectly normal, healthy, and inevitable aspects of the investing cycle. No specific fiscal or monetary policy changes can prevent these largely emotion-driven events from occurring.
What's important to recognize is that these cycles aren't linear.
In June 2023, shortly after the broad-based S&P 500 officially entered a new bull market, the analysts at Bespoke Investment Group published a data set to social media platform X (formerly Twitter) where they calculated and compared the calendar day length of every S&P 500 bull and bear market since the start of the Great Depression (September 1929).
On one end of the spectrum, the benchmark index's 27 bear markets have lasted an average of 286 calendar days (about 9.5 months) since September 1929. Further, the longest bear market on record for the S&P 500 endured for only 630 days in the mid-1970s.
Flipping the proverbial coin shows the average S&P 500 bull market stuck around for 1,011 calendar days, or approximately 3.5 times as long as the typical bear market. Additionally, if the current bull market were extrapolated to the present day, more than half (14 out of 27) of all S&P 500 bull markets have lasted longer than the lengthiest bear market.
Regardless of how dire any specific data set or correlative event might appear, downturns have consistently been short-lived and have, eventually, always given way to new all-time highs. Maintaining perspective and being optimistic is a formula that consistently grows stock investment portfolios on Wall Street.
Before you buy stock in S&P 500 Index, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the for investors to buy now… and S&P 500 Index wasn't one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Netflix made this list on December 17, 2004... if you invested $1,000 at the time of our recommendation, you'd have $669,517!* Or when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you'd have $868,615!*
Now, it's worth noting Stock Advisor's total average return is 792% — a market-crushing outperformance compared to 171% for the S&P 500. Don't miss out on the latest top 10 list, available when you join .
See the 10 stocks »
*Stock Advisor returns as of June 2, 2025
Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
The Stock Market Is in Ultra-Rarified Territory and Doing Something for Only the 3rd Time in 154 Years -- and History Is Crystal Clear What Happens Next was originally published by The Motley Fool