The S&P 500 closed at fresh record highs this week, capping off a strong start to 2026. But beneath the celebration lies a troubling data point that has some of Wall Street's most seasoned observers sounding alarm bells: stock market valuations have reached levels seen only twice before in 153 years of recorded history.

The Shiller PE ratio—a measure of stock prices relative to inflation-adjusted earnings over the prior decade—has climbed to 40.66. That reading places the current market among the most expensive ever, trailing only the dot-com bubble peak of 44.19 reached in late 1999.

A Once-in-a-Generation Valuation

The Shiller PE, also known as the cyclically adjusted price-to-earnings ratio or CAPE, was developed by Nobel laureate economist Robert Shiller to smooth out earnings volatility and provide a more stable measure of market valuation. Its long-term average since 1871 is approximately 17.3.

Today's reading of 40.66 represents a 135% premium to that historical average. Put differently, investors are paying more than twice what they've typically paid for a dollar of corporate earnings.

There have been only three instances in 155 years where the Shiller PE has topped 40:

  • December 1999: The ratio peaked at 44.19 during the dot-com bubble. The S&P 500 subsequently fell 49%, and the Nasdaq Composite crashed 78%.
  • November 2021: The ratio briefly exceeded 40 before the 2022 bear market wiped out $13 trillion in stock market wealth.
  • January 2026: Today's reading of 40.66 marks the third such occurrence.

The 'Year of the Bubble' Warning

The historical precedent has prompted some analysts to make bold—and bearish—predictions. Writing for The Motley Fool, senior analyst Sean Williams argues that 2026 may come to be known as the "Year of the Bubble," with as many as four potential asset bubbles threatening to burst.

"What the Shiller P/E has shown is that extended stock valuations aren't well tolerated over long periods," Williams wrote. "With up to four bubbles at risk of bursting in 2026, this may well be known as the 'Year of the Bubble' on Wall Street."

Beyond stocks, Williams identifies potential bubbles in:

  • Artificial intelligence: The AI trade has driven extraordinary gains in a handful of mega-cap technology stocks, with some trading at valuations that assume decades of flawless execution.
  • Cryptocurrency: Bitcoin's surge above $100,000 in 2025 has reignited speculative fervor across digital assets.
  • Housing: Despite higher mortgage rates, home prices remain near record highs in many markets.

The Bull Case: This Time Is Different?

Not everyone accepts the bearish interpretation. Bulls point to several factors that could justify elevated valuations:

Corporate profit margins remain robust. S&P 500 companies have maintained profit margins above historical averages, suggesting that earnings power may be structurally higher than in previous eras.

Interest rates are falling. The Federal Reserve has cut rates three times since September, and markets expect additional cuts in 2026. Lower rates typically support higher equity valuations.

AI productivity gains may be real. Unlike the dot-com era, when profits from internet technology remained largely hypothetical, today's AI leaders are generating substantial revenue and earnings.

"The journey to this valuation peak has been fueled by a relentless surge in artificial intelligence speculation and a resilient, albeit top-heavy, corporate earnings landscape," noted one market strategist. "Whether that speculation proves justified remains to be seen."

What History Actually Says

While the Shiller PE has proven useful for identifying periods of extreme valuation, its predictive power over shorter time horizons is limited. High valuations can persist for years before mean-reverting.

Consider that the ratio first exceeded 25 in early 1996. Investors who sold then missed several more years of gains as the dot-com bubble inflated further. The lesson: being early and being wrong can look identical in the short term.

That said, the historical record is clear about eventual outcomes. Every prior instance of extreme Shiller PE readings was eventually followed by significant drawdowns. The question is not whether markets will correct, but when.

The Fed's Dilemma

The Federal Reserve finds itself in a delicate position. With markets trading at historically elevated valuations, any hawkish shift to combat sticky inflation could trigger a sharp selloff. Yet maintaining an accommodative stance risks further inflating asset prices.

"With the market so highly valued, the Federal Reserve finds itself in a difficult position," one analyst observed. "Any hawkish tilt to combat lingering inflation could trigger a valuation collapse, while a dovish stance might further fuel an unsustainable bubble."

Capital Flows Tell a Story

Perhaps the most telling indicator: as U.S. market valuations have reached "once-in-a-century" levels, capital has begun flowing toward international markets that offer more reasonable valuations.

European and emerging market indices currently trade at significant discounts to the S&P 500's Shiller PE. Smart money appears to be hedging its bets, maintaining U.S. exposure while diversifying into cheaper markets abroad.

What Investors Should Do

The Shiller PE offers a warning, not a trading signal. Elevated valuations suggest lower expected returns over the next decade, but they don't prescribe specific actions for individual portfolios.

Consider these principles:

  • Expect lower returns: With valuations at these levels, the next 10 years are unlikely to match the last 10. Adjust expectations accordingly.
  • Maintain diversification: International stocks, bonds, and alternative assets may provide better risk-adjusted returns than an all-U.S. equity portfolio.
  • Keep perspective: Market timing is notoriously difficult. A disciplined, long-term approach has historically outperformed attempts to predict tops and bottoms.
  • Build cash reserves: Elevated valuations often precede volatility. Having dry powder to deploy during corrections can turn market stress into opportunity.

The Bottom Line

The Shiller PE's climb above 40 places today's market in rarefied air—a level reached only twice before in more than 150 years of market history. Both prior instances were followed by devastating bear markets.

That doesn't mean a crash is imminent. Markets can remain irrational longer than investors can remain solvent, as the saying goes. But it does suggest that the margin of safety for equity investors has narrowed considerably.

Whether 2026 becomes the "Year of the Bubble" remains to be seen. But investors would be wise to remember that trees don't grow to the sky—and neither do stock prices, no matter how compelling the narrative.