In October 2025, the U.S. stock market entered rare territory. According to data from economist Robert Shiller, the cyclically adjusted price-to-earnings ratio (CAPE) — commonly known as the Shiller P/E — has surpassed 40.
That may sound like just another statistic, but this level has been reached only three times since 1871: before the crashes of 1929, 2000, and now.
Each time the Shiller P/E has approached this level, what followed wasn’t a mild correction or short-term dip — it was a significant reset in equity valuations.
In this article, we’ll explore what the Shiller P/E represents, why it’s flashing red today, how it has historically foreshadowed market downturns, and what investors can do to prepare for the next phase of the market cycle.
1. Understanding the Shiller P/E (CAPE Ratio)
The Shiller P/E is a refined version of the traditional price-to-earnings (P/E) ratio. Instead of comparing the current market price to earnings from a single year — which can fluctuate widely due to business cycles — the Shiller P/E smooths out volatility by using average inflation-adjusted earnings over the past 10 years. CAPE=Current PriceAverage Real Earnings (10 years)\text{CAPE} = \frac{\text{Current Price}}{\text{Average Real Earnings (10 years)}}CAPE=Average Real Earnings (10 years)Current Price
This approach gives a long-term view of how expensive or cheap the market is relative to its historical earnings power.
2. Why a CAPE Above 40 Is Historically Rare — and Dangerous
Since the late 19th century, the average CAPE ratio for the S&P 500 has hovered around 16–17. It tends to rise during periods of optimism and fall during recessions.
Yet, crossing 40 is almost unheard of. According to data compiled by Shiller and recent reporting by The Motley Fool, this has happened only three times:
- 1929 – on the eve of the Great Depression
- 1999–2000 – during the dot-com bubble
- 2025 – the present era, driven by AI enthusiasm and a liquidity-rich environment
In both historical cases, the euphoric optimism that pushed valuations to extremes was followed by steep corrections: the Dow Jones lost nearly 85% after 1929, and the S&P 500 plunged almost 50% after 2000.
3. CAPE and Future Returns: A Clear Inverse Relationship
Decades of market research show a strong negative correlation between the CAPE ratio and subsequent 10-year real returns. In simple terms, when investors pay more for earnings (high CAPE), they tend to earn less in the decade ahead.
When the CAPE ratio is below 15, average real returns over the next 10 years often exceed 8% per year.
When the CAPE rises above 30, those returns usually fall below 2% per year, and periods above 40 have historically preceded market declines or stagnation.
4. Why the Market Is So Expensive Today
Several structural factors are fueling today’s lofty valuations:
- Low Interest Rates and Excess Liquidity: Despite rate hikes, real rates remain historically low, keeping borrowing costs attractive and equity valuations inflated.
- Technological Euphoria: The explosion of artificial intelligence and cloud infrastructure has led to soaring valuations in mega-cap tech stocks.
- Passive Investment Flows: The rise of index funds and ETFs continually channels money into large-cap stocks, pushing prices higher regardless of fundamentals.
- Optimistic Earnings Forecasts: Analysts expect record profits and margin expansion — assumptions that may prove too rosy if economic growth slows.
While these drivers explain why CAPE is high, they don’t guarantee it can stay high. Historically, the market eventually reverts to its long-term valuation mean.
5. What History Teaches About High Valuations
It’s tempting to think “this time is different,” but history shows valuation extremes always resolve — either through price declines or earnings catching up.
| Period | CAPE Peak | 10-Year Real Return | Outcome |
|---|---|---|---|
| 1929 | 33 | −2% per year | Great Depression |
| 1999 | 44 | −3% per year | Dot-com crash |
| 2021 | 38 | ~1% (projected) | Inflation + 2022 correction |
| 2025 | 40+ | TBD | ??? |
No bull market in modern history has sustained a CAPE above 35 indefinitely.
6. Could This Time Really Be Different?
Proponents of today’s high valuations argue that structural changes justify them:
- AI and Productivity Growth: Revolutionary technology may permanently lift corporate earnings.
- Global Demand for U.S. Assets: The dollar remains strong, and global investors continue to view U.S. equities as the safest long-term bet.
- Financialization of Markets: With trillions in retirement savings chasing returns, asset prices may remain elevated longer than in the past.
These arguments have merit, but they also echo the rationalizations of prior bubbles — from “new industrial age” rhetoric in the 1920s to “internet will change everything” in 1999.
7. The Correction Scenario: What Could Trigger It?
Corrections rarely happen because of valuations alone. They usually require a catalyst that forces investors to reassess risk.
Possible triggers include:
- Rising Interest Rates – Higher discount rates lower the present value of future earnings.
- Earnings Disappointments – Even minor misses can deflate overvalued stocks.
- Economic Slowdown – Slower GDP or consumer demand can quickly pressure margins.
- Geopolitical or Financial Shocks – Unforeseen events (war, credit stress, etc.) often burst valuation bubbles.
When expectations are this elevated, the market’s margin for error becomes razor-thin.
8. What Investors Can Do Now
- Rebalance portfolios toward value and defensive sectors (utilities, healthcare, consumer staples).
- Increase diversification across asset classes, including bonds, real assets, and international equities.
- Avoid leverage or speculative bets that assume continued multiple expansion.
- Maintain discipline — don’t try to time the exact top, but do recognize when risk-reward skews negative.
As Warren Buffett once said, “Be fearful when others are greedy.” The current CAPE suggests this may be one of those moments.
9. The Bottom Line
The Shiller P/E above 40 has historically marked moments of market euphoria and unsustainable optimism. While no single indicator can predict an exact crash date, the odds of below-average returns and increased volatility rise sharply from these levels.
If history rhymes, investors may soon face a reckoning — not necessarily an immediate collapse, but a gradual reversion to reality.
The CAPE ratio doesn’t tell us the day the market will turn, but it whispers the same warning it did in 1929 and 2000: valuations matter.