The stock market is currently experiencing a phenomenon that has occurred just three times over the past 153 years — and historical patterns strongly indicate what typically follows.

The S&P 500 has been on a strong upward trajectory, posting impressive gains of 24% in 2023 and 23% in 2024, and is currently on track for yet another double-digit yearly rise. The renowned index recently hit new all-time highs, further highlighting the momentum of the ongoing bull market.

What’s fueling this surge? Growth-oriented stocks, especially those tied to the rapid expansion of artificial intelligence (AI). Investors are enthusiastic about the transformative potential of AI and the advantages it offers to early adopters. Projections indicate the AI sector could reach trillions in value within the next decade, potentially driving significant growth for participating companies and their investors.

Additionally, the Federal Reserve cut interest rates last month and indicated that more reductions could be on the way. Lower rates tend to benefit businesses by reducing borrowing expenses and help consumers by increasing their purchasing power. This environment is favorable for growth stocks and the broader market alike.

While all of this appears promising, a rare recent event in the stock market may be signaling potential challenges ahead.

Concerns about Trump's tariff plan

It’s also worth mentioning that this year hasn’t been entirely smooth for investors. Earlier, markets dropped due to worries over President Donald Trump’s proposed import tariffs. However, as the administration showed some willingness to adjust certain tariffs and many businesses proved adept at navigating these obstacles, investor confidence returned.

Meanwhile, as previously noted, optimism was further supported by AI-driven growth and monetary policy shifts—and to top it off, corporate earnings were robust. According to BlackRock, 79% of S&P 500 companies exceeded analysts’ revenue expectations, and over 80% beat earnings forecasts in the second quarter, far surpassing the historical average of about 60%.

These factors have all contributed to the market’s rally, sending the S&P 500 to a series of new records—and causing the market to display a phenomenon seen only three times in the past 153 years. To understand this, it’s helpful to look at valuation metrics. Investors commonly use the price-to-earnings (P/E) ratio, which compares a stock’s price to its earnings, or the forward P/E, which uses projected earnings for the coming year. Both are valid tools for assessing a stock’s value.

The S&P 500 Shiller CAPE ratio

However, when evaluating the S&P 500 as a whole, another metric may provide even deeper insight, as it reflects changes in the economy and corporate profits over a ten-year span. This is the S&P 500 Shiller CAPE ratio, which measures price relative to average earnings per share over the past decade.

Recently, the S&P 500 Shiller CAPE ratio climbed above 36, a level reached only twice before in 153 years. This month, it even surpassed 39—a milestone not seen since the dot-com bubble in 1999, when it peaked above 44.

S&P 500 Shiller CAPE Ratio data by YCharts

So, what does this indicate? The overall stock market has become quite expensive. Historically, when valuations have reached these heights, subsequent declines have often followed.

S&P 500 Shiller CAPE Ratio data by YCharts

For instance, between December 1999 and December 2002, the S&P 500 dropped by over 37%. Similarly, after the previous peak in this metric in December 2021, the index fell 16% by December 2022.

A dark cloud -- but a silver lining

While history provides a clear warning about what might come next, there’s a bright side to this potential storm. In investing, time is a powerful ally. Although high valuations have often preceded downturns, the index has always managed to recover and reach new heights. Both bull and bear markets are natural parts of investing, and even the worst periods haven’t kept the index down for good.

This suggests that by focusing on strong companies with healthy finances and promising outlooks, investors can weather market corrections or crashes. In fact, downturns can present opportunities to buy quality stocks at attractive prices—and by remaining patient during volatile periods, you may position yourself for long-term success.