A Once-in-a-Generation Stock Market Warning Just Appeared. Investors Might Not Like What's Coming Next.

As of this writing on Aug. 5, the S&P 500 (SNPINDEX: ^GSPC) is trading at its highest level ever. It is on track to notch its sixth consecutive day of gains. Already, the S&P 500 index is up roughly 13% in 2026; if this bull market continues, the index will close 2026 with its fourth consecutive year of double-digit gains -- a multi-year streak not seen since the mid-90s dot-com era.

There's another similarity between today's bull market and the dot-com era's bull market. And while it doesn't mean today's market will meet the same fate as the dot-com crash, it is a strong warning that a downturn is likely coming. Here's what I mean.

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The S&P 500 is reaching extreme valuations unseen in decades

The S&P 500 Shiller CAPE ratio compares the S&P 500's current price with its average inflation-adjusted earnings over the past decade. Looking at a full decade of earnings, rather than just one or two years, helps smooth out the market's ups and downs. It's one of the most widely followed indicators of the stock market's valuation. And it has gotten seriously high.

Data by YCharts

As the chart above suggests, the CAPE has averaged about 16-17 over the last 150 years. Notice, for instance, that the CAPE has exceeded 24 only a handful of times. Many of those periods ended in some of the worst market crashes in history, including the Great Depression and the dot-com crash.

Only twice has the CAPE climbed above 40: first during the late 1990s when it peaked at about 44, and again today, when it sits at roughly 41.4. Put differently, investors are paying about $40 for every $1 of the S&P 500's average-inflation adjusted earnings over the last decade. Compared with a historical CAPE of 17, investors are paying roughly $23 more per dollar of earnings, or a premium of about 135% more.

A CAPE above 40 is a once-in-a-generation event -- or "twice" if you happened to be investing during the dot-com era. It doesn't mean a crash is imminent. However, it does show that investors are placing unusually high value on future growth. If that growth falls short of expectations -- say, if companies fail to earn an adequate return on their enormous artificial intelligence spending -- there could be a very painful reset in stock valuations.

The best strategies for investors right now

If the stock market is overvalued, as the CAPE suggests, the best strategy is to choose quality over hype. In practice, that could mean questioning stocks whose prices are driven more by speculation and promises than by business fundamentals. It can also mean putting financial health first; that is, looking for companies with low debt, abundant cash, consistent cash flow, and strong, stable earnings.

To be sure, high-quality stocks aren't always the most exciting investments, nor the most likely to post double-digit gains over the long run. If your strategy is growth, you might not be very inclined to restrict your selection to blue chip stocks and other safe stocks.

In that case, one of investing's oldest rules becomes especially important: Know what you're buying. Make sure you understand the business, the risks, and what must absolutely go right for its valuation to make sense before buying a speculative stock.

Historically, buying high-quality stocks has paid off over long periods. And while no stock is immune to market downturns, building a diversified portfolio around financially robust companies is still one of the best ways to prepare for whatever comes next.

Steven Porrello has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.