With the S&P 500 delivering double-digit growth in both 2023 and 2024, we’re on track to do something similar as we head into the last week of December 2025. For investors who have been enjoying these gains, this feels a little bit like validation for their willingness to hold on in what has been easily considered a volatile market.
If you are on the sidelines, you very well might be feeling like you have missed out on one of the best market runs in recent history. No matter which of these two sides you are on, there is something hidden underneath all of this celebration, as a rare market signal has come to the surface. Having only appeared once before, it carries a warning that every investor needs to understand.
While history doesn’t always repeat itself, it does sometimes follow very similar patterns, and this means you should be well aware of what happened the last time the market sustained this kind of strong momentum.
AI and Easy Rates: The Engine Behind Double-Digit S&P 500 Gains
Almost without question, the primary fuel for this multi-year period has been a sense of overwhelming optimism around artificial intelligence and a shift toward an easier interest rate environment. Investors have been pouring capital into mega-cap technology leaders like NVIDIA (NASDAQ:NVDA) and betting that AI is going to fundamentally reshape global productivity in the very same manner that the internet did almost two decades ago.
This sense of enthusiasm has driven the S&P 500 to a 26% gain in 2023 and a similarly strong return of 23% in 2024. With just over a week left of trading days in 2025, the double-digit ascent three years in a row is all but a sure thing. Beyond the conversation around AI, the Federal Reserve’s pivot toward lower interest rates has also acted as something of a significant tailwind for stock valuations. By proactively cutting rates three times since 2024, the central bank of the United States has lowered borrowing costs and has helped reinforce the argument around a “soft landing” scenario for investors.
This combination of innovation in the tech space and supportive liquidity has created a market that has essentially ignored what would otherwise be traditional headwinds. Instead, it’s pushing indexes to record highs even as concerns about valuation, especially in the tech space, begin to surface in the broader financial community.
The Once-in-a-Lifetime Market Signal and Investor Problem
The extraordinary run investors have been enjoying has now resulted in a market signal that has only been seen once before. This signal is that the S&P Shiller CAPE ratio (Cyclically Adjusted Price-to-Earnings) has crossed the 40 threshold. This metric, which measures the index’s price against its average inflation-adjusted earnings over the last ten years, provides a smoothed-out view of market valuation.
The only other instance in history that we have seen a similar situation was at the very peak of the dot-com bubble in 1999. Between 1995 and 1999, the S&P 500 posted five consecutive years of returns exceeding 20% annually. Understandably, investors were thrilled, and technology, similar to how AI is being viewed today, transformed the economy, and valuations didn’t matter because the old rules no longer applied, again, very similar to today.
If you are an everyday investor, this signal could be cause for concern as the market is currently trading at its second-highest valuation level in over 150 years. Ultimately, with a forward price-to-earnings ratio sitting near 23x, significantly above the 25-year average of 16.3x, the market is considered to be effectively priced for perfection. When valuations are this stretched, even a minor disappointment in corporate earnings or a Fed policy shift can trigger a sharp downturn. This results in investors being in somewhat of a precarious position where they must decide if the risk is worth the reward.
The problem really isn’t that the market is overvalued by any single metric, and markets can stay expensive for years. The problem is that after three consecutive years of double-digit gains, we’re in a market scenario that has very little room for any errors.
Analyzing the Precedent: What History Says Comes Next
For better or worse, history does give us a pretty clear and almost sobering forecast of what has typically followed such an extreme valuation peak. After the Shiller CAPE ratio passed 40 toward the end of 1999, the S&P 500 entered a multi-year decline, and the market lost roughly 37% of its value between December 1999 and December 2001.
Historical averages also show that once the market records a monthly CAPE ratio above 39, the index has typically declined an average of 4% over the next year and as much as 30% over a three-year horizon. On the plus side, there are some analysts who believe the current bull market still has some runway to keep growing due to the robust AI infrastructure spending and healthy corporate margins. Still, all of the signals point to a sense of overwhelming caution.
In every prior instance where the Shiller CAPE has topped 30, it was eventually followed by a significant drawdown that ranged from 20% to as high as 89%, both of which are not good for investors. It’s for this reason that the modern investor should heed this signal as a reminder that the underlying technology around AI might be truly transformative, but that the price being paid for this future is entering a market zone that has historically been preceded by some of the most difficult market periods for equity returns.
What Investors Should Do Right Now
Does this mean a crash is inevitable in 2026 or 2027? Not necessarily, as market conditions today are different in pretty substantial ways from years prior. Most importantly, corporate earnings are stronger and more broadly distributed, while AI is actually generating real revenue and not just the promise of revenue. Separately, the economy, while slowing, hasn’t fallen into recession.
Ultimately, the comparison isn’t trying to predict an exact repeat of 1999, but about recognizing that the same kind of momentum as that period creates very specific risks. This said, for investors that are heavily concentrated in mega-cap tech stocks, now is the time to diversify. The stocks that have been leading this current rally are also some of the most vulnerable if there is a sentiment shift.
The idea would be to take some profits that have been made out of tech and rotate them into dividend-paying stocks, international equities, or defensive sectors that can reduce exposure without abandoning the idea of growth entirely. Any concerns should be especially true for retirees, who should be particularly cautious as locking in some gains and shifting toward income-generating assets will protect against the desire to panic sell down the road.