The Buffett Indicator and Shiller P/E Ratio Are in Rarified Territory -- Are Things About to Get Ugly for Stocks?
Key Points
The S&P 500, Dow Jones Industrial Average, and Nasdaq Composite have been virtually unstoppable over the last five months and change.
Two of the stock market's most time-tested valuation tools -- the market-cap-to-GDP ratio and the S&P 500's Shiller price-to-earnings (P/E) Ratio -- are pushing to historic levels.
Every stock market correction throughout history has, in hindsight, proved to be an opportunity for long-term investors to pounce.
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Investors have been taken on quite the ride in 2025, but have been handsomely rewarded for their patience.
Shortly after President Donald Trump announced his tariff and trade policy on April 2, the broad-based S&P 500 (SNPINDEX: ^GSPC), widely followed Dow Jones Industrial Average (DJINDICES: ^DJI), and growth-dominated Nasdaq Composite (NASDAQINDEX: ^IXIC) plummeted. The S&P 500 endured its fifth-steepest two-day percentage decline since 1950, while the Nasdaq very briefly dipped into a bear market (its first in three years).
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But like waving a green flag on a race track, the S&P 500, Dow Jones, and Nasdaq Composite have been putting the pedal to the metal since April 9 -- the day President Trump paused higher "reciprocal tariffs" for dozens of countries. In roughly 5.5 months, the Dow, S&P 500, and Nasdaq Composite have rallied 23%, 33%, and 47%, respectively, with all three indexes climbing to record highs.
The stock market is riding a wave of optimism fueled by the prospect of future rate cuts, which can entice corporate borrowing, hiring, and innovation, as well as ongoing hype surrounding the evolution of artificial intelligence (AI).
Image source: Getty Images.
But based on what history tells us, outsized returns of this magnitude rarely occur without repercussions.
The "Buffett Indicator" just hit an all-time high
When it comes to assessing and identifying value, few investors have done a better job over the last 60 years than Berkshire Hathaway CEO Warren Buffett. He's overseen a nearly 20% annualized return for his company's Class A shares (BRK.A) and delivered an aggregate return nearing 6,000,000%.
Although Buffett doesn't have a specific valuation marker he uses, he did refer to the market-cap-to-GDP ratio in a 2001 interview with Fortune magazine as, "probably the best single measure of where valuations stand at any given moment." This measure, which adds up the value of all public companies and divides it by U.S. gross domestic product (GDP), has become known as the "Buffett Indicator."
When back-tested to 1970, the Buffett Indicator has averaged a ratio of 85%. This is to say that the cumulative value of all public stocks has averaged about 85% of U.S. GDP. On Sept. 14, the Buffett Indicator rocketed to a new all-time high of 218.12%, or a roughly 157% premium to its 55-year average.
Warren Buffett Indicator hits 215%, the most expensive stock market valuation in history 👀 pic.twitter.com/kjnbGN67be
-- Barchart (@Barchart) August 29, 2025
If you're wondering why Warren Buffett has been a net seller of stocks to the cumulative tune of $177.4 billion over the last 11 quarters, look no further than the Buffett Indicator.
Previous significant moves higher in the Buffett Indicator eventually gave way to significant Wall Street downside. This includes the dot-com bubble in 2000, as well as the 2022 bear market.
The Shiller P/E Ratio is a stone's throw from its second-highest multiple in 154 years
The problem for Wall Street and investors is that the Buffett Indicator is just one of two historically accurate valuation markers that portends big-time trouble for stocks.
When most investors think of "value," the traditional price-to-earnings (P/E) ratio likely comes to mind. The P/E of a stock is arrived at by dividing its share price by its trailing-12-month earnings per share (EPS). While the P/E ratio works great for evaluating mature/time-tested businesses, it often misses the mark with growth stocks and during recessions.
The S&P 500's Shiller P/E Ratio, which is commonly referred to as the cyclically adjusted P/E Ratio (CAPE Ratio), is a valuation tool based on average inflation-adjusted earnings from the previous 10 years. Utilizing a decade's worth of EPS history ensures that shock events and recessions won't meaningfully alter the results.
S&P 500 Shiller CAPE Ratio data by YCharts.
When looking back to January 1871, the S&P 500's Shiller P/E has averaged a multiple of 17.28. As of the closing bell on Sept. 18, the Shiller P/E hit 39.86, which is its highest level during the current bull market, and the third-highest level in 154 back-tested years.
Historically, a Shiller P/E above 30 has been a harbinger of a bear market to come. Including the present, there have been six instances where the CAPE Ratio topped 30. Following the prior five instances, the S&P 500, Dow, and/or Nasdaq Composite eventually plunged by anywhere from 20% to 89%.
Much like the Buffett Indicator, the Shiller P/E isn't a timing tool. As the past has shown, sometimes extended valuations stick around for two months, and occasionally premium valuations can be sustained for multiple years, as occurred prior to the bursting of the dot-com bubble. But the end result has always been the same: a minimum decline of 20% or greater for one or more of Wall Street's major stock indexes.
Based solely on what history tells us, things could, indeed, get ugly for stocks -- but there's also a silver lining.
Image source: Getty Images.
Stock market corrections have always represented buying opportunities for patient investors
Generally, investors dislike the prospect of significant downside for the stock market and their portfolios. As the popular stock market idiom goes, equities have a habit of taking the stairs up and the elevator down. As early April reminded investors, emotion-driven trading can lead to jaw-dropping single-session declines.
But here's the thing about elevator-down moves in the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite: they're short-lived and unsustained.
In June 2023, the analysts at Bespoke Investment Group examined the length of 27 separate S&P 500 bull and bear markets dating back to the start of the Great Depression in September 1929. Bespoke found the average 20% or greater downturn lasted just 286 calendar days (about 9.5 months), with just eight of these 27 events surpassing the one-year mark.
As for the 27 S&P 500 bull markets, 14 out of 27 have lasted longer than the lengthiest bear market (630 calendar days), and they, on average, stuck around 3.5 times longer (1,011 calendar days).
It's official. A new bull market is confirmed.
-- Bespoke (@bespokeinvest) June 8, 2023
The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.
Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp
Time tends to be even more of an ally if you look back further than 1929.
The analysts at Crestmont Research have calculated the rolling 20-year total returns of the S&P 500, which includes dividends paid, all the way back to 1900. Even though the S&P wasn't officially incepted until 1923, researchers tracked the performance of its components in other major indexes to the start of the 20th century.
What Crestmont discovered was that all 106 rolling 20-year periods they calculated produced positive annualized returns. In other words, if an investor had, hypothetically, bought the top, held through a recession or depression, a pandemic, a war, tariffs... you name it... from 1900 to 2005, and simply stuck with their position in an S&P 500-tracking index for 20 years, they would have generated a profit every single time.
What these data sets demonstrate is that every stock market correction dating back more than a century has turned into a buying opportunity for long-term-minded investors.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.
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