Are We Sleepwalking Into Another Severe Stock Market Selloff?

May 20

The chart I am looking at is hard to ignore. The Shiller PE ratio for the S&P 500 is sitting around 41, a level that has only appeared during some of the most expensive market environments in history.

It does not mean the market must crash tomorrow. It does not even mean the market cannot go higher. But it does tell me one uncomfortable thing: investors are paying an extremely high price for normalized earnings.

The Shiller PE ratio, also called the CAPE ratio, compares the current market price with the average of the past 10 years of inflation-adjusted earnings. The purpose is to smooth out recessions, profit booms, and temporary earnings distortions. A normal PE ratio can look reasonable at the top of an earnings cycle. CAPE asks a tougher question: how expensive is the market compared with long-term earning power? Current CAPE estimates around 41 place the S&P 500 near historically extreme valuation territory.

That matters because valuation is not a precise timing tool, but it is a powerful risk indicator. The market can stay overvalued for years, especially when liquidity, earnings momentum, and investor optimism are all aligned. But when valuation is stretched, the margin for error becomes thin. A small disappointment can become a large selloff because the price already assumes a very optimistic future.

My own position has been painful. In mid-March 2026, I sold all my stock investments. I believed the risk-reward setup had become unattractive.

Since then, the market has continued higher, and I still cannot quite believe it. I have paid the price for my conviction. That is important to admit because being early is functionally the same as being wrong for a while. But being early does not automatically mean the thesis is dead.

The first major bear-market argument is energy. The U.S./Israel war with Iran has created a serious oil-supply risk through the Strait of Hormuz, one of the world’s most important energy chokepoints. Reuters reported that normal vessel traffic through the strait had fallen dramatically during the conflict, with some crude shipments only recently resuming after long delays.

This is not a minor geopolitical headline. It is a direct macroeconomic threat. The IMF described the disruption around the Strait of Hormuz and damaged regional infrastructure as a major shock to global oil markets, with energy acting as the primary transmission channel into the wider economy.

So far, the stock market has largely looked through this risk. That may be rational if investors believe the conflict will be contained, oil flows will normalize, and central banks will tolerate temporary inflation. But I am not convinced the market has fully priced in the second-round effects: higher transport costs, lower consumer spending power, pressure on corporate margins, and renewed inflation expectations.

The second bear-market argument is the AI investment boom. I do believe artificial intelligence is real. This is not like every worthless dot-com company from 1999. Many of today’s AI leaders have enormous revenues, real customers, and world-class balance sheets. That is the balanced side of the argument.

But real technology can still create a financial bubble. Railroads, automobiles, the internet, and telecom infrastructure were all real. Investors still overpaid. The danger is not that AI is fake. The danger is that the market may be pulling forward too much future profit too quickly.

Goldman Sachs recently estimated that AI-related capital expenditure across compute, data centers, and power could reach roughly $7.6 trillion between 2026 and 2031. That is an extraordinary number. Reuters also reported that AI-related financing is helping drive a surge in U.S. convertible bond issuance, with AI companies accounting for nearly half of early-2026 issuance.

That tells me the AI boom is moving beyond software optimism and into heavy capital formation. Data centers, chips, power infrastructure, cooling, land, debt, and energy contracts are now part of the story. This can support growth, but it also increases operating leverage. If expected AI returns disappoint, the unwind could be brutal.

The third concern is market concentration. The S&P 500 looks strong on the surface, but the strength is not evenly distributed. Recent reporting showed that a small group of large companies has driven most of the 2026 gains, while much of the rest of the index has lagged or declined.

This matters because a concentrated market is fragile. When leadership narrows, the index becomes dependent on a handful of stocks continuing to beat expectations. If Nvidia, Alphabet, Microsoft, Apple, Amazon, Meta, or Tesla stumble, the “market” can suddenly look much weaker than the index previously suggested.

The bullish counterargument: Earnings may continue to grow. AI may generate enough productivity gains to justify higher valuations. Inflation may cool despite oil volatility. The Federal Reserve may eventually cut rates. Investors may keep rewarding the companies with the strongest balance sheets, and the market may climb the wall of worry again.

But my concern is that too many risks are now stacked on top of each other: extreme CAPE valuation, geopolitical oil risk, narrow market breadth, AI capex exuberance, and investor confidence that bad news will not matter. That combination does not guarantee a crash. It does create the conditions where a correction can become severe if confidence breaks.

The hardest part about bear-market thinking is psychological. You can be fundamentally right and financially wrong for months. That is where I am. I sold too early, and the market has punished me. But when I look at this Shiller PE chart, the oil shock risk, and the AI investment cycle, I still struggle to call this a healthy long-term entry point.

My conclusion is not that investors should panic. Panic is not a strategy. My conclusion is that the S&P 500 is priced for near perfection at a time when the world is far from perfect. When valuations are this high, the question is not whether good things can still happen. They can. The question is whether enough good things can happen to justify the price already paid.

Right now, I think the market is walking a narrow ridge. It may keep climbing. But if oil, inflation, AI expectations, or mega-cap earnings turn against it, the downside could be much steeper than investors currently believe.

Jun 5

Note

This could be the start of a major correction