The Stock Market Just Breached a Never-Before-Seen Threshold — and History Couldn’t Be Clearer About What Happens Next

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It’s been quite a phenomenal two years for investors. Since bottoming out in October 2022, the iconic Dow Jones Industrial Average (DJINDICES: ^DJI), broad-based S&P 500 (SNPINDEX: ^GSPC), and innovation-driven Nasdaq Composite (NASDAQINDEX: ^IXIC) have all soared to multiple record-closing highs.

The stock market’s epic rally is being fueled by the rise of artificial intelligence (AI), excitement following President-elect Donald Trump’s victory, and corporate earnings growth widely surpassing consensus expectations.

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While seemingly nothing looks to be standing in the way of these three catalysts, history isn’t as forgiving.

Image source: Getty Images.

Over the last year, there has been no shortage of economic data points or forecasting tools that have warned of potential trouble for the U.S. economy and/or Wall Street. Examples include the first notable decline in U.S. money supply since the Great Depression, the longest yield-curve inversion on record, and a record high for the “Buffett Indicator.” However, there’s a new concern to add to the list: the benchmark S&P 500’s price-to-book (P/B) ratio.

For individual companies, their book value effectively shows what shareholders would receive if a company were, hypothetically, liquidated (i.e., its assets minus liabilities). While book value isn’t quite the imperative fundamental metric it once was, it still serves an important function in helping value investors identify undervalued stocks.

However, book value isn’t just a metric used for individual businesses. We can examine the collective book value of the companies that comprise major indexes to determine if the components, as a whole, are collectively cheap or pricey.

Over the last 25 years, the S&P 500’s P/B value has averaged 2.83, which isn’t particularly low, nor is it egregiously high. With the internet democratizing access to information in the mid-1990s and interest rates tumbling following the financial crisis, investors have been encouraged to take on more risk and invest in growth stocks, which would be expected to lead higher P/B ratios.

But there’s an undeniable threshold the S&P 500 has crossed that’s eventually (key word!) led to trouble every single time.

S&P 500 Price to Book Ratio Chart
S&P 500 Price to Book Ratio data by YCharts. Readings are tabulated quarterly, with the latest reading (4.793) for the chart above from Sept. 30, 2024.

Prior to 2024, there had only been two instances in a quarter of a century when the S&P 500’s P/B ratio surpassed 4 during a bull market rally:

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