The U.S. stock market, as measured by the S&P 500, is closing out another solid year. With just a few trading days left in 2025, it’s up over 17 percent. Once again, buy and hold index fund investors have been rewarded for their mindless rigor.
Good for them. A bull market is no time for sound thinking and contemplating risk. Blindly riding the index higher is both fun and easy. The results are gratifying.
Nonetheless, we believe now is precisely the time to consider risk and a prudent portfolio allocation. It is highly likely 2026 will be less pleasant for S&P 500 index investors who bet the farm on its perpetual buoyancy.
The uncomfortably fact is we’re currently staring at a stock market that is, by almost every historical metric, priced for perfection. In our experience, perfection is a very high bar to clear.
Fundamentals may be boring. They may seem irrelevant and outdated after such an extensive bull market run. But if you ignore them, you’re doing so at great peril.
Fundamentals, by definition, never go away. There may be extended periods where they seem to have disappeared. But like a night prowler, they’re always lurking, waiting for just the moment when you’ve let your guard down.
As we roll into 2026, investors would be wise to keep their dukes up. This is no time for complacency. Investment fundamentals always reappear at the worst possible time – when everyone expects stocks will only go higher.
If the S&P 500 closes out December in the green, which it appears it will, this would mark an 8-month streak of positive closes. This would be the longest streak since the 10-month streak that ended in January 2018.
So perhaps there will be another month or two of a rising stock market. But all win streaks are eventually broken. This one, no doubt, is moving towards its end.
The Ghost of 1999
The big banks, like Morgan Stanley, JPMorgan Chase, and UBS, all see the S&P 500 going up by 10 to 15 percent in 2026. Bank of American has a more modest estimate of 5 percent. The general consensus is that Federal Reserve rate cuts, artificial intelligence (AI) efficiency gains, and accommodative regulatory and tax policies will float the index higher.
This ignores market fundamentals. And while this has been advantageous for the last three years, we believe, in 2026, basic market fundamentals will crash the party.
If you want to understand why the bears see gloom and doom, just take a look at the Shiller PE Ratio – also known as the Cyclically Adjusted Price Earnings (CAPE) ratio.
Unlike a standard P/E ratio that just looks at the last year of earnings, Professor Robert Shiller’s version takes the average of the last 10 years of earnings, adjusted for inflation. It’s like looking at a person’s average health over a decade instead of just how they felt after a good night’s sleep and a cup of coffee.
The Shiller PE is currently over 40. To put that in perspective, the historical average is roughly 17. Thus, we are currently 135 percent above the long-term trendline. The only other time it was higher was in December 1999, when it hit 44 right before the dot-com bubble burst. We all know how that ended.
When the Shiller PE is this high, the market is essentially expecting the next decade to be the greatest economic run in human history. If it’s anything less than that – say, just a decade of moderate growth – stocks have to fall (or stay flat for a long time) to let the earnings catch up to the price.
Most likely, stock prices will suffer an abrupt decline to come in line with earnings.
Big Problems
Right now, the stock market is riding high in fantasyland. There is an unfounded belief that AI will boost productivity so much that profit margins will stay at record highs forever. So far, AI has failed to deliver on this promise of productivity gains and mushrooming revenues. What if AI turns out to be a great big capital destroying dud?
Investors are also banking on Fed rate cuts to keep credit flowing and further inflate stocks. We all know that consumer price inflation is well above what’s reported. The prospect of another big break out – like in 2022 – isn’t out of the question.
How long can the Fed cut rates and juice the economy before there’s another consumer price inflation flareup? Should prices spike again, the Fed will have to decide between maintaining an asset bubble or limiting a currency crisis.
There’s also the expectation that corporate earnings will continue to grow. In fact, current estimates project double-digit earnings growth for 2026. Most of these projections look at the recent past and extend it out into the future. What if businesses cannot deliver the expected growth?
In addition, there’s the problem of market concentration. The top 10 stocks in the S&P 500 now make up about 40 percent of the index. At the peak of the dot-com bubble the top 10 stocks only accounted for about 29 percent of the S&P 500.
Many index fund investors believe they’re diversified. In reality, they’re unwittingly betting on a handful of tech companies to keep hitting grand slams every single inning. When 10 stocks make up close to 50 percent of the index, you can expect there will be big problems.
History suggests that such an extreme narrowing of market breadth often precedes a violent correction.
Why Market Fundamentals Always Win in the End
“Markets can remain irrational longer than you can stay solvent.” We’ve all heard that remark from John Maynard Keynes.
Ultimately, the laws of math are undefeated. Market fundamentals eventually reassert themselves through a process called mean reversion. The stock market can run above or below its average for an extended period. But it must always revert to its average at some point or another.
There can be countless triggers for a sky-high market to reverse course. For example, as the 10-year Treasury yield stays above 4 percent, it acts as a competitor for your money. Why bet on a tech stock with a 40 P/E ratio when you can get a guaranteed 4 percent from the government?
What if there’s an earnings miss? High valuations leave zero room for error. If a hot tech company reports 12 percent growth instead of the 15 percent the market expected, the stock will quickly sell off.
There could be any number of things that precipitate a bear market. The point is, when the Shiller PE is at extreme highs (like now), the subsequent 10-year returns are almost always flat or negative in real terms. In other words, the current risk-to-reward ratio for owning stocks is incredibly lopsided.
Quite frankly, you don’t have to be a gloom and doomer to recognize that the math simply doesn’t add up. Fundamentals aren’t a theory or idea. They are a natural law – like gravity – that holds the financial world together.
And while the market can float high above the real economy for a while, gravity always, always wins. You can take that to the bank.
[Editor’s note: Join the Economic Prism mailing list and get a free copy of an important special report called, “Utility Payment Wealth – Profit from Henry Ford’s Dream City Business Model.” If you want a special trial deal to check out MN Gordon’s Wealth Prism Letter, you can grab that here.]
Sincerely,
MN Gordon
for Economic Prism
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