Over the last century, no other asset class has come particularly close to rivaling stocks in annualized returns. While bonds, commodities, and real estate have all increased in value, the Dow Jones Industrial Average (^DJI 0.56%), S&P 500 (^GSPC 0.11%), and Nasdaq Composite (^IXIC +0.35%) have outpaced them all.
But just because stocks outperform over extended timelines, it doesn’t mean they’re without periods of heightened volatility and declines.
At any given time, several catalysts threaten to pull the rug out from beneath investors. While many of these concerns eventually fade without issue, some turn into bona fide problems for Wall Street. One historical concern, raised last year by Federal Reserve Chair Jerome Powell, foreshadows big-time trouble for stocks.
Fed Chair Jerome Powell delivering remarks. Image source: Official Federal Reserve Photo.
Fed Chair Powell doesn’t mince words when talking about the stock market
Typically, members of the Federal Open Market Committee (FOMC) — the 12-person body responsible for setting U.S. monetary policy — including Fed Chair Powell, avoid making direct commentary about the stock market. The FOMC’s job is to uphold the dual mandate of maximizing employment and stabilizing prices. How the Dow, S&P 500, and Nasdaq are performing is rarely of any consequence to the dual mandate.
But on rare occasions throughout history, Fed chairpersons have chimed in about one specific, historical stock market risk: valuations.
In December 1996, Fed Chair Alan Greenspan delivered his impassioned “irrational exuberance” speech that highlighted the rapid appreciation of stocks following the advent and mainstream proliferation of the internet. While the dot-com bubble eventually burst, the peaks of the Dow, S&P 500, and Nasdaq didn’t occur until more than three years after Greenspan’s speech.
In September 2025, Powell broke from tradition and directly addressed stock market valuations following a speech. In response to a reporter’s question about how the FOMC accounts for equity valuations in its monetary policy decisions, Powell replied:
We do look at overall financial conditions, and we ask ourselves whether our policies are affecting financial conditions in a way that is what we’re trying to achieve. But you’re right, by many measures, for example, equity prices are fairly highly valued.
It’s these final six words, “equity prices are fairly highly valued,” that should terrify Wall Street.
Image source: Getty Images.
Jerome Powell’s warning to Wall Street is still truer than ever
Despite making this comment about stocks in mid-September, the broader market became even pricier, with the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average reaching psychologically important plateaus of 7,000, 24,000, and 50,000, respectively.
But more than six months later, Powell’s comments ring true from a historical standpoint. Though it’s impossible to pinpoint when the music will stop on Wall Street, history has served as a guide, more often than not, for investors… and apparently Fed chairs.
The valuation tool that’s sounding alarm bells on Wall Street is the S&P 500’s Shiller Price-to-Earnings (P/E) Ratio, which is also known as the Cyclically Adjusted P/E Ratio (CAPE Ratio).
Whereas the time-tested P/E ratio accounts for trailing 12-month earnings and can be easily tripped up by recessions and shock events, the Shiller P/E is based on average, inflation-adjusted earnings over the previous 10 years. The CAPE Ratio remains useful in any economic climate.
Although economists introduced the CAPE Ratio in the late 1980s, it’s been back-tested over 155 years to January 1871. Over this lengthy span, the S&P 500’s Shiller P/E has averaged 17.35. But the stock market began 2026 with its second-priciest valuation in history — a Shiller P/E above 40.
S&P 500 Shiller PE Ratio hits 2nd highest level in history 🚨 The highest was the Dot Com Bubble 🤯 pic.twitter.com/Lx634H7xKa
— Barchart (@Barchart) December 28, 2025
While the S&P 500’s Shiller P/E isn’t a timing tool, it does have a historically immaculate track record of foreshadowing steep declines in the Dow Jones Industrial Average, S&P 500, and/or Nasdaq Composite. The five previous times it’s surpassed 30 during a continuous bull market were all followed by drops of 20% to 89% in one or more of Wall Street’s major stock indexes.
Narrowing things even further, the CAPE Ratio has topped 40 on just three occasions in 155 years, including the current bull market. The prior two instances — a 21-month stretch during the dot-com bubble and the first week of January 2022 — gave way to 49% and 25% peak-to-trough declines in the S&P 500, respectively.
While inflationary worries surrounding the Iran war briefly sent the Dow and Nasdaq into correction territory, it hardly made a dent in a historically expensive stock market. As of this writing, following the closing bell on April 6, the Shiller P/E is back above 38.
In addition to notable declines in the major stock indexes, history has shown that no significant downturn has ended with a Shiller P/E above 27. If this is the minimum line in the sand for Wall Street, the benchmark S&P 500 could lose a third (or more) of its value.
Although Jerome Powell’s time as Fed chair is winding down, his words of wisdom about equity valuations on Wall Street ring truer than ever.
