Warren Buffett's Last Warning About the Stock Market Could Haunt Wall Street for Years. History Says This Will Happen Next.

Warren Buffett is undoubtedly one of the most influential figures in modern finance. Under his leadership, Berkshire Hathaway evolved from a small textile manufacturer into one of the largest conglomerates in the world. Buffett's patient, value-oriented investments were essential to that transformation.

One way to quantify his success is to examine Berkshire's returns when he led the company. Between 1965 and 2025, the stock gained almost 20% annually, crushing the S&P 500 (SNPINDEX: ^GSPC), which added about 11% annually during the same period.

Last December, after six decades at the helm, Buffett retired and handed the CEO position at Berkshire to Greg Abel. Despite stepping back from the media spotlight, Buffett did pass a warning to investors during a recent CNBC interview, and it could haunt Wall Street for years.

Image source: Getty Images.

Warren Buffett says investors are treating the stock market like a casino

Warren Buffett, now 95 years old, sat down for an interview with CNBC in May. He talked about everything from nuclear weapons and geopolitical risk to artificial intelligence (AI) and the macroeconomic environment. But a few comments stood out.

While discussing the market's increasingly speculative behavior, Buffett said, "We've never had people in a more gambling mood than now." He also warned that some investors were treating the stock market like a casino, making irresponsible bets that have left an awful lot of valuations looking "very silly."

Buffett has issued similar warnings before, so investors may be tempted to brush aside his most recent comments. Unfortunately, a respected stock market indicator just sounded an alarm that lends credence to Buffett's casino analogy, and it hints at trouble for Wall Street in the years ahead.

The S&P 500's CAPE ratio is extremely high by historical standards

In 1988, Nobel Prize-winning economist Robert Shiller and his colleague John Campbell introduced the cyclically adjusted price-to-earnings (CAPE) ratio. The metric was designed to determine whether entire stock market indexes were overvalued, and it correctly predicted the dot-com crash around the turn of the century.

Unlike traditional price-to-earnings multiples, which are based on earnings from the last four quarters, CAPE multiples are based on average inflation-adjusted earnings from the last 10 years, which eliminates cyclical noise and smooths the effects of economic cycles.

The S&P 500 recorded a monthly CAPE ratio of 40.6 in July, the highest reading since the dot-com crash in September 2000. In fact, there have been only 30 instances since the index was created in 1957 when the S&P 500's monthly CAPE ratio was at least 40, which means the stock market has been this expensive only 3% of the time.

Unfortunately, such rich valuations have historically been a harbinger of significant losses. The chart below shows the S&P 500's best, worst, and average returns over different periods after a CAPE reading above 40.

Data source: Robert Shiller, YCharts.

There are two important takeaways in the chart. First, the S&P 500 has never delivered a positive three-year return following a monthly CAPE reading above 40. Second, if the S&P 500's future returns match the historical average, the index will drop 30% over the next three years.

Here's the big picture: Warren Buffett recently warned investors that the stock market has become increasingly casino-like, with speculative bets pushing some valuations to silly levels. That warning could haunt Wall Street for years because the CAPE ratio, a valuation metric that correctly predicted the dot-com crash, is flashing a warning today.

Of course, past performance is no guarantee of future results. And the internet boom did not drive the same type of earnings momentum we have seen lately from the AI boom. S&P 500 companies are forecast to report 50% earnings growth in the second quarter, the strongest pace on record outside of post-recession recoveries.

The CAPE ratio is a backward-looking valuation metric, meaning it does not account for the possibility of a sustained increase in future earnings growth. But if S&P 500 companies maintain their momentum, the index could continue to rise while the CAPE drops to a more reasonable level. In that scenario, the stock market could avoid a steep sell-off.

Trevor Jennewine 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.