The Inevitable Reckoning

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The recent ascent of the market – the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite – has been noted. A 13%, 16%, and 20% increase respectively, accompanied by a string of record closings. It is a spectacle, certainly, and one fueled by narratives of artificial intelligence, quantum computing, and a conveniently timed easing of interest rates. Corporate earnings, too, have been presented as robust, and share buybacks have reached unprecedented levels. One might be forgiven for believing this prosperity will continue indefinitely.

However, a principle long observed in this profession suggests caution. When circumstances appear excessively favorable, a critical reassessment is warranted. The market, after all, is not governed by optimism alone, but by the cold logic of valuation. And it is here that a disquieting picture emerges.

There exists a forecasting tool, refined over 155 years of observation, that possesses a remarkable, if unsettling, record of accuracy. It does not predict when a correction will occur, but rather, that one is likely given current conditions. This tool, based on the Shiller P/E ratio – or Cyclically Adjusted Price-to-Earnings ratio – indicates a substantial decline in the S&P 500 is not merely possible, but probable.

The Weight of Valuation

The difficulty lies in assigning a precise value to any enterprise, let alone an entire market. Subjectivity is inherent. What one investor deems a bargain, another may consider exorbitant. This, coupled with the emotional currents that drive trading, contributes to the market’s inherent volatility. The standard P/E ratio, while useful, is limited by its reliance on a single year of earnings. It fails to account for the cyclical nature of economic activity.

The Shiller P/E, by averaging inflation-adjusted earnings over a decade, offers a more robust measure. It smooths out short-term fluctuations and provides a clearer picture of long-term affordability. As of February 3, 2026, the S&P 500’s Shiller P/E stood at 40.32. The historical average, dating back to 1871, is 17.33. The discrepancy is not negligible.

Statistical analysis reveals that such a premium over historical norms is unsustainable. In the past 155 years, there have been six instances of the CAPE Ratio exceeding 30 for a sustained period during a bull market. In each case, the market subsequently experienced a decline ranging from 20% to 89%.

The Shiller P/E does not offer a precise timetable. But it does suggest the magnitude of a potential correction. Based on historical patterns, a decline to a Shiller P/E of 27 would require a drop of at least 33% in the S&P 500, bringing it back to the 4,600 range after recently surpassing 7,000. This is not a prediction, but a logical consequence of present valuations.

To ignore this is to court delusion. The market is not a benevolent force, nor is it guided by wishful thinking. It is a mechanism, responding to fundamental forces, and those forces suggest a reckoning is at hand.

The Long View

It is important to remember that market cycles are inevitable. Periods of growth are invariably followed by periods of correction. This is not a cause for despair, but a recognition of reality. History demonstrates that bull markets tend to outlast bear markets, and that long-term returns remain positive.

Analysis of the past 94 years reveals that bear markets rarely persist for extended periods. The average bear market trough is reached after approximately 9.5 months. Bull markets, on the other hand, tend to be more enduring, lasting an average of 1,011 days and generating returns of 114.4%.

While a significant correction is probable, it should be viewed as a temporary setback within a longer-term trend of growth. The market will eventually recover, and new opportunities will emerge. However, to assume this recovery will be immediate or effortless is a mistake. Prudence, and a realistic assessment of risk, are essential.

The market is not a machine for generating perpetual wealth. It is a complex system, subject to unpredictable forces. To understand it, one must abandon illusions and embrace the cold logic of reality. And that reality, at this moment, suggests a period of turbulence lies ahead.

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2026-02-08 14:43