In the past, this signal has always preceded major market downturns. Here’s what to really expect on Wall Street.
This signal is shaking Wall Street. In the last 150 years, it has happened only three times, and two of those times it heralded one of the worst crashes in financial history: the Dot-com bubble in 2000 and the steep correction of 2022. Today, in the fall of 2025, that signal has returned. And on Wall Street, where stock markets continue to set record highs, some are starting to wonder if the party is (really) over.
On paper, the picture seems almost perfect. The American economy is holding up, inflation is slowing, and artificial intelligence remains the main driver of index growth. The S&P 500, the Dow Jones, and the Nasdaq are rising relentlessly, fueled by a euphoria reminiscent of the heyday of the dot-com boom.
And according to several analysts, current valuations cannot be explained by fundamentals.
When euphoria becomes a warning bell
History teaches us that when enthusiasm becomes widespread, perhaps it’s time to look up.
Because every time the Shiller CAPE ratio has surpassed the 40 threshold, markets have corrected sharply. In 1999, this indicator (which measures stock prices relative to average inflation-adjusted earnings over the last ten years) reached 44. Over the next three years, the S&P 500 lost nearly half its value, and the Nasdaq fell 78%. In 2022, it reached similar levels, predicting a 25% decline.
Today, we’re back there, at 40.32 points. A value that indicates a market "overvalued" relative to fundamentals, at least based on historical parameters. This doesn’t mean a crash is imminent, but it does suggest that US stocks are too expensive relative to their earnings.
Many analysts argue that this time is different, that the artificial intelligence revolution can truly rewrite the rules of the game and sustain endless growth. But it doesn’t take much to break the spell. A macroeconomic data set below expectations, a slowdown in profits, or a technological stumble, and the same euphoria currently supporting stock markets could suddenly turn into their greatest weakness.
Warning Signs for Investors
The elevated CAPE ratio above 40 signal doesn’t say "when" the market will fall, but it warns of "how much" room there is before it does. Those who have invested in the last two years and now find themselves with profitable portfolios know that the markets are stretched to the limit.
Beyond the CAPE ratio, there are other signals that send the same message. The S&P 500 forward price-to-earnings ratio has risen to 23, well above the historical average, while the "Buffett Indicator," which measures market capitalization relative to GDP, points to a financial economy more bloated than ever.
In the current environment, characterized by high valuations and signs of structural excess, portfolio strategy should return to being guided by fundamentals. Interest rates are indeed falling, but remain significantly higher than pre-pandemic levels. This implies a structurally higher cost of capital compared to the 2010-2020 decade and, consequently, a natural compression of equity multiples. In other words, equity risk premium remains elevated, and the market is no longer willing to pay any price for the promise of future growth.
|DISCLAIMER
The information and considerations contained in this article should not be used as the sole or primary basis for making investment decisions. The reader retains full freedom in their investment decisions and full responsibility for making them, as only they know their risk appetite and time horizon. The information contained in this article is provided for informational purposes only, and its disclosure does not constitute and should not be considered an offer or solicitation to the public.
Original article published on Money.it Italy 2025-10-16 06:38:00. Original title: Mercati, questo segnale è apparso solo 3 volte dal 1871. E ogni volta è finita male
