Warren Buffett’s Stark Warning: A Business Historian’s Perspective on Market Woes

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Berkshire Hathaway (BRK.A 0.28%) (BRK.B 0.60%) shares have witnessed a remarkable increase of over 5,500,000% since the year 1965, a feat accomplished under the wise stewardship of Warren Buffett, whose investing style, akin to the meticulous care of an accomplished gardener tending to the soil, has yielded an annual compounding return of 20%. The patience of Mr. Buffett, which could almost be deemed an art form, has cultivated this immense growth. Indeed, the portfolio of this esteemed institution now boasts a staggering value in excess of $300 billion.

However, as we examine more recent developments with an eye to the future, it becomes evident that Berkshire Hathaway’s actions signal a certain unease. Since the S&P 500 entered a bull market in the final quarter of 2022, Mr. Buffett and his fellow managers have, rather inexplicably, been net sellers of stocks. For twelve consecutive quarters, they have sold more than they purchased, a staggering $184 billion worth of stock having passed from their hands.

That such a sale should occur at all is, in itself, disquieting, but it is the enormity of Berkshire’s cash reserves that adds an especially unsettling layer to this cautionary tale. In the third quarter of 2025, the company held a record sum of $381 billion in cash and short-term investments. One might reasonably ask, why, in the face of such abundance, has there been such reluctance to invest? One possible explanation may lie in the sheer size of Berkshire’s holdings. With the company now so vast, it is conceivable that few acquisitions would meaningfully alter the balance of its financial fortunes. Furthermore, the stocks that might indeed make a difference are likely either deemed too expensive or, in the case of Mr. Buffett, fall outside the realm of his considerable expertise. Alternatively, the market as a whole may present, in Mr. Buffett’s seasoned view, an unsatisfactory valuation.

The S&P 500’s High Valuation: A Harbinger of Market Decline?

In November, the S&P 500 was marked by an exceptionally high cyclically adjusted price-to-earnings (CAPE) ratio of 40-an occurrence so rare that it has only been recorded on twenty-two occasions since the index’s inception in 1957. This figure suggests a market at its most expensive, with the index now priced at levels that have historically led to a period of prolonged decline. The CAPE ratio, developed by economist Robert Shiller, stands as a more reliable gauge of market value than traditional price-to-earnings (P/E) ratios, as it smooths the volatility that naturally arises in any business cycle by considering inflation-adjusted earnings over a ten-year span.

When examining past occurrences of a CAPE ratio above 40, one finds that the S&P 500 has never once posted a positive return over the subsequent three years. The chart below provides a sobering look at the returns following such a high valuation:

Time Period S&P 500’s Best Return S&P 500’s Worst Return S&P 500’s Average Return
1 year 16% (28%) (3%)
2 years 8% (43%) (19%)
3 years (10%) (43%) (30%)

The ramifications are as clear as they are ominous. Following a monthly CAPE ratio exceeding 40, the S&P 500 has never produced a positive return in the following three years. Indeed, the average return during this period has been an unfortunate decline of 30%, suggesting a bleak outlook for the index by December 2028.

Yet, Are We Right to Fear Such a Decline?

It must be acknowledged, however, that the CAPE ratio is not without its limitations. While it provides a reflective glance at past earnings, it fails to anticipate future growth-a matter of some importance when forecasting market conditions. Over the past decade, the S&P 500 has benefited from an expansion of its net profit margins, a trend largely driven by tax cuts and, more notably, the pervasive influence of technological innovation. This upward trajectory may well continue, especially as companies adopt artificial intelligence tools, thus presenting investors with a more optimistic view than the mere number on the CAPE scale might suggest.

Should earnings growth accelerate as anticipated, the S&P 500’s elevated valuation could be tempered without the dramatic fall that historical trends might imply. Nevertheless, there is no denying the undeniable fact that the current market is indeed expensive, and as such, volatility is to be expected. Investors, therefore, would do well to avoid chasing after speculative stocks-those with inflated valuations-and instead should practice a selective approach, mirroring Mr. Buffett’s own discernment. Indeed, it may be wise to part with any stocks that bring discomfort, for it is certainly better to avoid the temptation of exuberance than to risk being caught in the inevitable downturn.

One might be wise to remember that prudence, as Mr. Buffett himself has demonstrated, is often the truest form of genius.

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2025-12-04 12:02