The S&P 500 has generated an average annual return of 21% since 2023, nearly triple its long-term average of about 7% after adjusting for inflation and dividends. Artificial intelligence has been a key driver of this multi-year rally.
Investors are now watching valuation indicators closely. The cyclically adjusted price-to-earnings ratio currently sits at 39.8. This level was last reached in 2000, just prior to the dot-com crash.
Historical data shows only two other periods when the CAPE ratio reached such heights: the dot-com era and the 1920s. Both were followed by significant market corrections. The ratio's rise reflects broad market optimism that often precedes lower returns as premium prices become fragile.
The S&P 500's total market capitalization stands at $58 trillion. The ten most valuable companies account for roughly $26 trillion, or 44% of the index. Many of these top companies, including Nvidia, Alphabet, Meta Platforms, Broadcom, Amazon, and Taiwan Semiconductor Manufacturing, appear reasonably valued based on forward earnings multiples.
This concentration means the index's movements are heavily influenced by a small group of trillion-dollar companies benefiting from AI. The most expensive positions may lie outside the largest stocks by market cap.
Some investors are reducing exposure to volatile growth stocks and speculative positions. They are focusing on durable businesses with diversified models and maintaining cash reserves. This approach aims to strengthen portfolios regardless of whether a market correction occurs in 2026.
The Motley Fool Stock Advisor analyst team recently identified ten stocks they consider better investments than the S&P 500 Index. Their service has achieved a total average return of 958%, significantly outperforming the S&P 500's 196% return. Past recommendations include Netflix and Nvidia, which generated substantial gains for investors who followed the advice.