The Stock Market is Flashing Several Warning Signs at Once. Does That Mean a Crash is Imminent?
There have been many headlines recently about the stock market flashing warning signs. I’ve even written some of them. However, even when several signs flash at once, they don’t mean a crash is imminent because they don’t all tell us the same thing.
Instead, what they do signal is that now is the time to be more prepared. Here’s how to read these signs and prepare your portfolio for what could lie ahead.
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The trio of warning signs
The stock market regularly experiences meaningful downdrafts. It has historically corrected (a 10% or more decline) roughly once every 18 months and tumbled into a bear market (a 20% or more drop) about once every six years. However, it doesn’t move in that exact pattern. That’s why investors are always looking for signs that another meaningful decline could be on the horizon.
One sign that has historically preceded a major decline is an elevated CAPE ratio (cyclically adjusted price-to-earnings ratio). It measures whether the market is undervalued or overvalued relative to its historical inflation-adjusted earnings record. It’s currently at 40.5; it’s the second-highest reading in 150 years. Its prior peak was just before the dot-com crash. It was last above 40 in late 2021, right before the 2022 rate-driven bear market.
Speaking of rates, the Federal Reserve just started raising interest rates for the first time in three years. According to data from LPL Financial, the S&P 500 (SNPINDEX:^GSPC) has declined in five of the last six Fed rate-hike cycles (including 2022).
Finally, there’s margin debt, which has surged 49% over the past year. According to data from Fundstrat Global Advisors, the market has declined five out of six times when margin debt has surged 45% or more year-over-year since 1960.
The outliers and the case for optionality
While all that sounds foreboding, none of these signs mean a crash is forthcoming, as they’re not perfect predictors. For example, while a high CAPE ratio is a strong indicator of lower market returns over the longer term, it doesn’t mean the market will crash next year. For example, it was above 30 in 2018. The next year, the S&P 500 rose 29%. It’s also worth noting that the S&P 500 didn’t decline during the 1997 rate-hike cycle (though that was only a 25-basis-point increase). Meanwhile, the S&P 500 was up 12 months following a 45% (or more) year-over-year increase in margin debt one out of every six times. For example, it last hit that level in October 2025, but was up 10.9% 12 months later.
So, we shouldn’t read all these signs as imminent warnings of a crash. Instead, they should serve more as a reminder that the market does correct from time to time, and we need to ensure our portfolios remain prepared for the next downturn.
One way we can do that is by selling lower-conviction holdings to raise cash and by trimming positions where current valuations require perfect execution to deliver acceptable returns. That would build cash to capitalize on a meaningful decline in the coming months.
Now’s also the time to build a watch list of stocks you want to buy if there is a downdraft. For example, Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) is one of my higher-conviction holdings. It has a dominant search business and a growing cloud business, which is just scratching the surface of its AI potential. However, at 26 times forward earnings, Alphabet isn’t cheap enough for me to add to right now, given that the tech-heavy Nasdaq-100 index trades at about 21.5 times forward earnings. It’s also investing heavily in AI ($180 billion to $190 billion this year), increasing its risks. While Alphabet’s AI investments could drive meaningful growth in the coming years, I’d like a little more margin of safety. If Alphabet’s stock got down closer to $300 per share (around 22.5x forward earnings), I’d start buying more.
Don’t panic, prepare
With the market flashing lots of warning signs these days, it’s easy to become fearful that it’s about to crash. However, there’s no guarantee this will happen, as these aren’t perfect predictors. Meanwhile, even if a downdraft did happen, it’s far better to see one not as a threat but as an opportunity. The best way to do that is to use the warning signs as a signal to be better prepared by building cash and a watch list now, so you can capitalize on any potential opportunities that may arise in the near term.
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Matt DiLallo has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet. The Motley Fool has a disclosure policy.
The Stock Market is Flashing Several Warning Signs at Once. Does That Mean a Crash is Imminent? was originally published by The Motley Fool