The Stock Market Sounds an Alarm for the First Time in 25 Years. Here’s What History Says the S&P 500 Will Do in 2026
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Throughout the artificial intelligence (AI) revolution, the S&P 500 has generated returns nearly threefold higher than its long-term average.
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More signs are pointing to the stock market being overvalued, potentially signaling a sell-off could be on the horizon.
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Smart investors are buying quality businesses and stockpiling cash right now.
The long-run average return of the S&P 500 (SNPINDEX: ^GSPC) is about 7% after both inflation and dividend reinvestment are taken into account. Thanks to tailwinds from artificial intelligence (AI), however, the stock market has been on a historical rally for a few years now.
Since 2023, the S&P 500 has generated a return of 21% per year on average — essentially triple the index’s long-term average. While AI remains the market’s biggest theme, smart investors are looking beyond soaring stock prices and paying attention to more nuanced valuation indicators.
Below, we’ll dig into an important metric used to gauge the stock market’s health and assess where the S&P 500 could be headed based on historical data.
The chart below illustrates trends in the cyclically adjusted price-to-earnings (CAPE) ratio. The CAPE ratio is pretty nifty because it measures stock prices relative to earnings growth over 10 years — essentially creating a normalized view of valuation, independent of one-time anomalies as well as inflation.
The CAPE ratio currently sits at 39.8. The last time it reached this height was in 2000, just prior to the dot-com crash.
Investors can see that there are only two other times in history that the CAPE ratio soared to such abnormally high levels. In addition to the dot-com era, it happened in the 1920s.
In both instances, the stock market sustained historic drops, ushering in a period of brutal corrections. Against this backdrop, history suggests that the stock market could very well be headed for a reversal not only in 2026, but also beyond this year.
But a rising CAPE ratio doesn’t necessarily guarantee an imminent sell-off. Rather, when the ratio continues to surge, it tends to reflect broader optimism across the market, which can, and often is, eventually followed by lower returns as premium prices become increasingly fragile.
While the stock market could be on a collision course with history, smart investors should take a step back.
The S&P 500 currently has a total market capitalization of $58 trillion. The 10 most valuable companies in the world have a combined market value of roughly $26 trillion — or 44% of the index.
