introduction

In May 2026, the S&P 500 et Nasdaq closed at fresh all-time highs. On the surface, this looks like good news. Markets rising, portfolios growing, optimism everywhere. But beneath the record-setting headlines, a growing chorus of analysts, central bankers, and famous investors is warning that stocks may be dangerously overvalued.

The Buffett Indicator, a measure favoured by Warren Buffett himself, has hit 227%, well into what he once called “playing with fire” territory. The Shiller P/E ratio, another widely watched valuation metric, sits above 40, a level only seen twice before in over 150 years of market history. Both of those previous instances were followed by major crashes.

So is the stock market in a bubble? And if it is, what should investors actually do about it?

This article breaks down the key warning signs in plain language, explains what they do and do not tell us, and looks at how investors can think about risk without panicking.

 

What Is a Stock Market Bubble?

A bubble is what happens when asset prices rise far above their underlying value, driven not by fundamentals but by speculation, optimism, and the fear of missing out. Bubbles tend to follow a recognisable pattern: a genuine innovation or opportunity attracts investment, prices rise, the rising prices attract more investors, and eventually valuations detach completely from reality. At some point sentiment shifts, and prices fall sharply as everyone heads for the exit at once.

History offers plenty of examples. The dot-com bubble of the late 1990s saw internet companies with no profits reach enormous valuations before collapsing in 2000-2002. The US housing bubble of the mid-2000s ended in the 2008 financial crisis. Further back, there was the 1920s stock boom that preceded the Great Depression.

The tricky part is that bubbles are almost impossible to identify with certainty until after they burst. Markets can stay expensive for years, and “expensive” does not automatically mean “about to crash.” This is what makes the current debate so difficult.

 

Warning Sign 1: The Buffett Indicator

The Buffett Indicator compares the total value of the stock market to the size of the economy, measured as total market capitalisation divided by gross domestic product. The logic is intuitive. Over the long run, the stock market cannot grow much faster than the economy that supports it. When the ratio gets very high, it suggests stocks are expensive relative to economic output.

Warren Buffett once described this as “probably the best single measure of where valuations stand at any given moment.” He suggested that when the ratio approaches 200%, investors are “playing with fire.”

As of April 2026, the Buffett Indicator stands at around 227%. That is roughly one-sixth above the level Buffett identified as the danger zone, and one of the highest readings ever recorded.

However, the indicator has limitations. It does not account for interest rates, corporate profit margins, or the increasingly global nature of revenue for large US companies. Many analysts argue the threshold for “expensive” has shifted over time. Still, even accounting for these caveats, the current reading is historically extreme.

 

Warning Sign 2: The Shiller P/E Ratio

The Shiller P/E ratio, also called the CAPE ratio, was developed by Nobel laureate Robert Shiller. It compares stock prices to average inflation-adjusted earnings over the previous ten years. By smoothing earnings over a decade, it strips out short-term distortions and gives a clearer picture of long-term valuation.

The historical average Shiller P/E is around 17. Entering 2026, it sat above 40. That is the second-highest reading since 1871, surpassed only by the peak of the dot-com bubble.

What makes this concerning is the track record. The two previous occasions when the Shiller P/E exceeded 40 were followed by market declines of roughly 49% during the dot-com crash and 25% during the 2022 bear market. High valuations do not predict when a downturn will come, but they have historically been associated with weaker long-term returns and deeper drawdowns.

 

Warning Sign 3: AI Spending and Concentration

A significant portion of the market’s gains has been driven by a small number of very large technology companies, most of them tied to the artificial intelligence boom. The five largest hyperscalers are projected to spend more than $700 billion on AI data centre infrastructure in 2026 alone, more than the GDP of all but about two dozen countries.

This concentration is a double-edged sword. On one hand, these companies are highly profitable and the AI demand is real. On the other, when a market’s performance depends heavily on a handful of stocks all tied to the same theme, the risk of a sharp correction rises if that theme disappoints.

Michael Burry, the investor who famously predicted the 2008 housing crash, has warned that the market’s fixation on AI is starting to resemble the final stages of the dot-com bubble. Not everyone agrees, but the comparison is being made more frequently as valuations climb.

 

The Other Side: Why This Might Not Be a Bubble

It would be easy to read the warning signs and conclude a crash is imminent. But there is a serious counterargument worth understanding.

Unlike the dot-com era, today’s market leaders are extraordinarily profitable. The blended net profit margin for the S&P 500 in the first quarter of 2026 was 13.4%, the highest level recorded since this data began being tracked in 2009 (admittedly not a long track record). Estimated earnings growth for 2026 exceeds 20%. These are not speculative companies with no revenue, they are some of the most profitable businesses in history.

The AI investment boom, while enormous, is also generating real revenue and productivity gains, not just hype. Cloud computing demand is strong, corporate earnings are robust, and the broader economy, despite geopolitical shocks like the Strait of Hormuz crisis, has proven more resilient than many expected.

There’s also a macro factor that doesn’t get as much attention as it should: the sheer amount of money sloshing around the global financial system. Years of pandemic-era stimulus, quantitative easing and historically low interest rates have left the global money supply at record levels. That money has to go somewhere, and a meaningful portion has flowed into financial assets, including stocks. Higher valuations may partly reflect this excess liquidity rather than pure speculation. It doesn’t rule out the bubble argument, but it suggests that even “expensive” valuations can be sustained as long as the money supply remains elevated.

High valuations can also persist for a long time. Markets were considered expensive in 2015, 2017, and 2019, yet continued rising for years. An expensive market is not the same as a market that is about to fall. Investors who sat out of stocks waiting for a crash over the past decade missed substantial gains.

The honest answer is that nobody knows for certain. Valuations are stretched by historical standards, but fundamentals are stronger than in previous bubbles. Both things can be true at the same time.

 

What History Teaches Us

Looking back at previous periods of high valuations offers some useful lessons rather than precise predictions.

First, high valuations tend to predict lower long-term returns, not the timing of a crash. Markets can remain expensive for years before correcting. Trying to time the exact top is extremely difficult, even for professionals.

Second, the depth of a downturn often correlates with how stretched valuations were beforehand. The most severe crashes, 2000 and 2008, followed periods of extreme valuation. This does not guarantee a similar outcome now, but it argues for caution and preparation.

Third, diversified investors who stayed invested through previous downturns generally recovered and went on to new highs, provided they did not sell at the bottom. The biggest destroyer of long-term returns is not the crash itself, but panic selling at the worst possible moment. The key here being “long-term”, since the market may take many years to climb, albeit inexorably, back to pre-crash levels. 

 

What This Means for Your Portfolio

If you are concerned about elevated valuations, there are sensible approaches to consider that do not involve trying to predict the market’s next move. These are not intended as financial advice for your particular portfolio and situation but as general rules of thumb.

  • Review your asset allocation. If a strong market run has left you with far more in equities than you are comfortable with, rebalancing back toward your target allocation is a disciplined way to manage risk. This naturally involves trimming winners and is not the same as trying to time the market.
  • Diversify across regions and asset classes. Concentration risk works both ways. A portfolio heavily weighted toward US large-cap technology is highly exposed to a single theme. International equities, bonds, and alternative assets can reduce the impact of a downturn in any one area.
  • Keep some dry powder. Holding a reasonable cash buffer means you are not forced to sell during a downturn and gives you the flexibility to invest when prices are lower. This is about resilience, not market timing.
  • Focus on time in the market, not timing the market. For long-term investors, regular investing through ups and downs has historically been more effective than waiting for the perfect entry point. Volatility is the price of admission for long-term returns.
  • Stay informed, not reactive. Understanding what is driving markets helps you respond to events calmly rather than emotionally. Reacting to headlines with panic decisions is one of the most reliable ways to damage long-term returns.
  • Know your own risk tolerance. The most important question is not whether a bubble exists, but whether your portfolio could withstand a significant drawdown without forcing you into bad decisions. If the answer is no, that is worth addressing regardless of where valuations sit.

 

Conclusion

Is the stock market in a bubble? The warning signs, the Buffett Indicator, the Shiller P/E, and the concentration of gains in AI-related stocks, are flashing at levels not seen in decades. These signals deserve serious attention and should not be dismissed.

At the same time, today’s market leaders are genuinely profitable, earnings are growing, and the economy has proven resilient. Expensive markets can stay expensive for a long time, and history is full of investors who lost money betting on a crash that took years to arrive.

The most useful takeaway is not a prediction but a mindset. Rather than trying to guess when or whether a bubble will burst, focus on building a portfolio that can survive whatever comes next: diversified, aligned with your risk tolerance, and resilient enough that you will not be forced into panic decisions. That approach works regardless of whether the warning signs prove right.

 

Staying on Top of Market Risk

Markets move fast, and the narrative around valuations, AI spending, and macroeconomic risk shifts constantly. Staying informed without drowning in noise is one of the biggest challenges investors face today.

CityFALCON’s AI-powered financial intelligence platform helps investors track the news and signals that matter most. Our system aggregates and scores content from thousands of sources, letting you monitor market sentiment, valuation debates, central bank commentary, and individual company developments in one place. Access to real-time intelligence via our API makes it easier to stay informed and make calmer, better-informed decisions.

Explore more at cityfalcon.ai.