When the Market's Three-Year Run Matches History's Warning Signs

The S&P 500 is trading at levels that history flags as perilous. Over the past three years, the index has surged a staggering 80%, delivering one of the most powerful rallies in its 153-year history. This pace translates to an annualized return that more than doubles the long-term average, a feat that has only occurred twice before. The last two instances-the 1920s bull market and the late 1990s tech boom-both ended in devastating crashes. That pattern alone is a stark warning.

The index's current valuation is even more concerning. It recently hit record levels, with the Shiller CAPE ratio-a measure of earnings over a decade-climbing to 39. That figure is a level last seen just before the dot-com bubble burst. For context, the forward P/E multiple, which prices stocks against expected earnings, sits at 22. That multiple is historically elevated, having been seen only during the dot-com frenzy and the pandemic-era liquidity boom.

Put simply, the market is experiencing a rare, powerful surge while trading at record valuations. History suggests this setup is a classic precursor to a major correction. The combination of three consecutive double-digit annual gains and frothy metrics like a CAPE near 40 signals that the market's recent run may be running out of steam.

The Mechanism: What's Driving the Run and the Risk

The rally's engine is clear. For three straight years, the market has been propelled by growth stocks, particularly companies involved in the artificial intelligence (AI) boom. Investors have poured money into these firms, betting on transformative technology and future dominance. This speculative enthusiasm has been amplified by a supportive policy backdrop. The Federal Reserve began cutting rates in 2024 and continued to do so last year, lowering borrowing costs for companies and offering relief to consumers. This combination-a powerful narrative around AI growth and a lower interest rate environment-has fueled the market's ascent.

Yet, this powerful rally exists in stark contrast to the real economy. New data reveals a slowdown. Since President Trump's tariffs took effect, unemployment has reached a four-year high, with the rate climbing to 4.6% in November 2025. More telling is the labor market's pace: the U.S. economy added an average of just 55,000 jobs per month through November 2025, the weakest monthly average since the Great Recession. This divergence is a classic warning sign. It mirrors conditions before past major corrections, where stock prices climbed on optimism while underlying economic fundamentals weakened.

The setup is a familiar one. History shows that when valuations become stretched during a powerful bull run, the market can become detached from economic reality. The current pattern-a three-year gain of 80% driven by AI hype, while jobs growth hits a multi-decade low, is structurally similar to the late 1990s. Then, too, the market was led by tech growth stocks while the broader economy showed signs of strain. The risk now is that this disconnect makes the market vulnerable to a reversal when the economic data continues to deteriorate, or when the AI narrative faces a reality check.

Valuation and the Historical Precedent

The high CAPE ratio is not just a number; it is a historical signal with concrete consequences. When the S&P 500's CAPE ratio has been above 39, the market's path over the next year has been notably poor. Historical data shows that in such overvalued regimes, the index's average one-year return has been negative, with a wide range from a potential gain of +16% to a steep decline of -28%. This stark range underscores the heightened uncertainty and risk that follows such extreme valuations.

The precedent from the 1920s and the late 1990s is even more telling. In both cases, the market experienced an extended, high-performance bull run that ended in a devastating downturn. The three-year gain of 80% we are seeing now mirrors those earlier surges, which were driven by transformative narratives-the automobile and electrification in the 1920s, the internet in the 1990s. History suggests that when a bull market's performance reaches this rare, powerful level, it often sets the stage for a major reversal. The 1920s boom led to the Great Depression, and the late 1990s tech boom ended in the dot-com bust.

More broadly, the data reveals a persistent drag on long-term results as valuations rise. While the best, worst, and average returns all trend worse as the CAPE ratio climbs, the pattern is clear: elevated prices today tend to deliver lower returns tomorrow. The current CAPE of 39.9 places the market in a category with a proven track record of delivering negative or muted returns over the subsequent 1-3 years. For investors, this is the core lesson from history: powerful rallies that push valuations to extreme levels often come with a built-in cost.

Catalysts and What to Watch

For investors, the historical pattern sets a clear framework: the market's powerful run is now vulnerable. The key is to monitor the near-term triggers that will validate or invalidate this warning. Three areas demand close attention.

First, watch the trajectory of corporate earnings. The market's lofty valuation, with a forward P/E multiple of 22, prices in perfection. Any failure for earnings growth to keep pace with soaring stock prices would confirm the overvaluation. The current setup is precarious; as history shows, when expectations outstrip reality, even good news can disappoint. The market has been driven by AI stock enthusiasm, but that narrative requires sustained, robust profit expansion to hold. A slowdown in earnings acceleration would be the first crack in the foundation.

Second, a sustained acceleration in economic weakness is a powerful catalyst for a market repricing. The recent data is already a red flag: unemployment has hit a four-year high, and jobs growth is at a multi-decade low. If this trend deepens into a recession, it would force a fundamental reassessment of corporate profits and risk. The market's detachment from economic reality, a hallmark of past major corrections, would likely end abruptly. The tariffs that have shaped this economic headwind are a tangible source of that pressure.

Finally, the most immediate catalyst is a shift in market sentiment. The rally has been fueled by optimism around AI and a supportive rate-cutting environment. The risk is that this optimism begins to crack, replaced by a focus on valuation and economic risk. When the conversation turns from "what can AI do?" to "how much are we paying for it?" and "what does a weak economy mean for earnings?", a pullback becomes likely. The historical precedent is clear: powerful bull markets that reach these rare, frothy levels often end not with a whimper, but with a sharp repricing as sentiment flips. For now, the market is in a holding pattern, but the warning signs are flashing.