S&P 500 CAPE ratio tops 40 for second time since 1871

The S&P 500's Shiller CAPE ratio topped 40 in June, only the second time since 1871, a level that has preceded every U.S. equity selloff.

"We've never had people in a more gambling mood than now," Warren Buffett, the former Berkshire Hathaway chief executive, told CNBC in May, warning that speculative bets had left an awful lot of valuations looking "very silly."

The gauge, which smooths 10 years of inflation-adjusted earnings, closed at 42.56 on Aug. 14, near its bull-market high of 42.84 and a step from the all-time peak of 44.19 set in December 1999. It has exceeded 30 on just six occasions since 1871; after each of the prior five, the Dow, S&P 500, or Nasdaq lost 20 percent to 89 percent of their value.

The stakes are high for investors. Invesco found the S&P 500 delivered negative annualized returns over the following decade when the CAPE ratio surged to frothy levels, and the gauge has never produced a positive three-year return after a monthly reading above 40.

40 Has Been Reached Only Twice in 155 Years

The S&P 500 Shiller CAPE ratio, developed by Yale economics professor Robert Shiller, measures the index's price-to-earnings multiple using a 10-year moving average of inflation-adjusted earnings. From 1871 through 2000, the metric averaged roughly 15.7 and stayed below 25 for most of U.S. market history.

The indicator did not breach 30 until 1929, when the market crashed and the Great Depression began. It then stayed below that threshold for nearly seven decades. In early 1999, the CAPE ratio topped 40 for the first time, rising above 41 later that year and holding that elevated level until October 2000. The dot-com bubble burst, sending the S&P 500 more than 45 percent below its peak; the index took nearly seven years to recover fully.

More than two decades passed before the gauge again crossed 40, in June 2026. The S&P 500 recorded a monthly CAPE ratio of 40.6 in July, the highest since the dot-com crash in September 2000. Since the index was created in 1957, there have been only 30 instances — about 3 percent of the time — when the monthly CAPE ratio reached at least 40.

History Points to Negative Returns

The historical record is unsparing. After a monthly CAPE reading above 40, the S&P 500 has averaged a 3 percent loss over one year, a 19 percent loss over two years, and a 30 percent loss over three years, according to data compiled by Invesco. The index has never delivered a positive three-year return following such a reading.

The CAPE ratio tends to revert to its mean, and there are only two ways that happens: valuations fall, or earnings rise sharply. The former is far easier than the latter. This time may differ, though — S&P 500 earnings are rising faster than valuations, and companies are forecast to report 50 percent earnings growth in the second quarter, the strongest pace on record outside post-recession recoveries. That was not the case during the dot-com era, when many public companies were losing money.

Risk-taking has also climbed. Outstanding margin debt hit an all-time high of $1.502 trillion in June, up roughly 67 percent over 15 months, a parabolic rise that has preceded each of the last three major downturns.

For investors, the prudent path is to favor high-quality businesses with strong long-term growth and reasonable valuations relative to that growth, and to hold cash to deploy if a steep selloff arrives. That is the approach Buffett has taken, and it is the one most likely to weather a market that history suggests is expensive.

This article is for informational purposes only and does not constitute investment advice.