The S&P 500 has delivered strong gains over the past several years. Artificial intelligence remains a dominant investment theme, and stock valuations have climbed well above historical averages. Whenever markets reach these levels, discussions about an impending crash tend to follow — and with good reason.
Indeed, history offers a useful perspective.
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The CAPE ratio
One of the most widely followed valuation measures is the Shiller P/E CAPE ratio, which compares stock prices to average inflation-adjusted earnings over the previous 10 years. Historically, elevated CAPE ratios have been associated with lower long-term returns and, in some cases, major market corrections. And today, the CAPE ratio remains elevated.
That doesn’t mean a crash is imminent, though.
History shows that expensive markets can remain expensive for years. In fact, the CAPE ratio first moved above its long-term average in the mid-1990s, yet the market continued rising for several more years before the dot-com bubble eventually burst.
Market concentration
Another indicator attracting attention is market concentration. A relatively small group of technology companies now accounts for an unusually large share of the S&P 500’s value.
Nvidia (NASDAQ: NVDA), Microsoft (NASDAQ: MSFT), Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), Alphabet (NASDAQ: GOOG), Meta (NASDAQ: META), and Broadcom (NASDAQ: AVGO) have become so large that their combined market value exceeds that of entire sectors of the economy. And when these stocks move higher, they can pull the broader market with them. The reverse is also true, of course. If investor sentiment shifts, weakness in just a handful of names can have a meaningful impact on major indexes.
Similar periods of concentration have occurred before. During the “Nifty Fifty” era of the early 1970s — when roughly 50 big stocks were bought at any price — and the internet boom of the late 1990s, investors crowded into a handful of dominant companies. In both cases, the broader market eventually experienced significant declines.
Of course, there are important differences between today’s environment and past bubbles. Many of today’s largest companies are highly profitable, generate substantial cash flow, and hold strong balance sheets. Unlike many internet companies during the dot-com era, these businesses are producing real earnings and returning capital to shareholders.
