Key Points
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Stocks have been doing well in recent years, and valuations look inflated today.
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The Shiller price-to-earnings ratio is around 39 — the highest it’s been in decades.
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Predicting a market crash, however, is by no means easy.
The stock market appears to be on shaky ground of late, as the S&P 500 (SNPINDEX: ^GSPC) and the Nasdaq are both down this year. There appears to be considerable apprehension from investors of late, as there’s plenty of uncertainty around the economy, and the war in Iran adds yet another element of risk into the equation. On top of all this, stocks entered the year at fairly high valuations.
As a result, investors are concerned about what will happen with the stock market this year. It’s off to a slow start, but by no means is it in a full-blown free fall, at least not yet anyway. Is a crash inevitable, and if so, what should you do?
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A slowdown may be inevitable, but a crash isn’t necessarily a guarantee
It’s not hard to make a case for why the stock market should decline this year, but whether it will is another story. Consider that in each of the past three years, the S&P 500 has outperformed its long-run average of 10%. In 2023 and 2024, it rose by more than 20%. Last year, its 16% gain was its worst performance during that three-year period, and that’s still well above its historical average.
The S&P 500’s valuation also looks inflated when you look at the Shiller price-to-earnings ratio, which is at around 39 — the highest it’s been since the early 2000s. The ratio is based on inflation-adjusted earnings over the past decade and is a good gauge of how cheap or expensive stocks are. And right now, they look expensive, even with the recent softness in the market.
A crash could very well be coming, but you only have to look to last year as to why it may not be worth trying to predict one. It was almost a year ago when reciprocal tariffs were announced, which spooked the market. At the time, you may have very well expected a crash to happen. And while the market did initially fall, the S&P 500 would end up having another above-average performance. It’s another example of why trying to time the market may not be worth the effort.
Long-term investors are still better off remaining invested
There’s no guarantee of what will happen in the stock market in any given year. That’s why the world’s smartest and richest investors like Warren Buffett remain invested for the long haul. There will be bad years along the way, but the market has always rebounded.
One way to reduce your risk is to simply track the S&P 500’s performance through index funds. That way, you can have broad exposure to the overall market without having to worry about picking individual stocks, and you can have the confidence in knowing that over the long term, your portfolio is likely to rise in value.
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David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.
