With the S&P 500 near record highs and market valuations stretched, investors face growing signals that a bear market could be on the horizon. Learn how to assess your portfolio's risk and prepare for increased volatility
After nearly four years of strong gains in U.S. stocks, investors are once again weighing the risk that the next bear market could be approaching. While no one can predict exactly when a downturn will hit, several market indicators are flashing caution, prompting many to revisit their investment strategies and risk exposure.
Historically, bear markets-defined as a drop of at least 20% from recent highs-have occurred about once every six years since 1970. The last major downturn arrived in 2022, when the S&P 500 fell roughly 25% from January through mid-October. Although averages suggest another bear market could emerge within the next two years, market cycles are rarely predictable. For example, the U.S. market went more than a decade without a bear market from 2009 to 2020, but saw four separate downturns in the 2000s alone, including two of the most severe on record.
Valuation Signals and Market History
One of the most closely watched warning signs is the Shiller price-to-earnings (P/E) ratio, also known as the cyclically adjusted P/E (CAPE) ratio. This measure smooths out earnings over a 10-year period and adjusts for inflation, offering a broader view of market valuation than the standard P/E. As of August 2026, the Shiller P/E stands at 42-just below its all-time high of 44 reached in late 1999, shortly before the dot-com bubble burst. Elevated valuations do not guarantee an imminent downturn, but they have often preceded periods of heightened volatility and lower returns.
According to data from The Hartford Funds, the 2000 bear market lasted about 540 days with a 37% decline, while the 2007-2008 downturn spanned over 400 days and saw stocks drop by more than half. These episodes underscore that while bull markets can run for years, sharp reversals can erase gains quickly, especially when valuations are stretched.
Portfolio Risks and Diversification
For investors, the first step in preparing for a potential bear market is to review portfolio holdings for outsized risks. Stocks with unusually high P/E ratios-especially those trading at 50 or 60 times earnings-may be more vulnerable to steep declines if sentiment shifts. While some growth stocks can justify higher multiples, excessive valuations often signal greater downside in a correction.
Concentration in a handful of large-cap or growth stocks can also increase risk. Over time, these winners may come to dominate a portfolio, leaving investors exposed if market leadership rotates. Diversifying across value stocks, international equities, small-caps, and high-yield dividend payers can help cushion losses and provide exposure to areas that may recover faster after a downturn. Investors should also be wary of speculative stocks with little or no earnings, as these tend to fall hardest in bear markets.
Asset Allocation and Defensive Moves
Rebalancing asset allocation is another key defense. Vanguard's model portfolio, for example, currently recommends a mix of 36% U.S. stocks, 24% international stocks, and 40% bonds (split between U.S. and international fixed income). Bonds can provide stability and income when stocks decline, though their performance depends on interest rate trends and credit risk. Exchange-traded funds (ETFs), especially those that are actively managed, offer built-in diversification and allow professional managers to adjust holdings as market conditions change.
Bear markets can also present opportunities for disciplined investors. When valuations fall, high-quality companies may trade at more attractive prices, allowing long-term investors to buy shares at a discount. Still, timing the market is notoriously difficult, and most experts recommend maintaining a consistent investment approach aligned with personal goals, risk tolerance, and time horizon.
According to S&P Dow Jones Indices, the S&P 500 returned an average annualized 10.7% from 1970 through 2025, but those returns were punctuated by sharp declines during bear markets. The index's largest annual loss in that period was 38.5% in 2008, while the strongest gain was 37.6% in 1995. These swings highlight the importance of diversification and a long-term perspective, especially when market valuations are elevated.
Understanding Market Cycles
Market cycles are shaped by a complex mix of economic growth, corporate earnings, interest rates, investor sentiment, and global events. While high valuations and long bull runs can increase the risk of a downturn, no single indicator can reliably predict when a bear market will begin or how severe it will be. Investors who focus on fundamentals, maintain a diversified portfolio, and periodically rebalance are generally better positioned to weather volatility than those who try to time the market or chase recent winners.
Valuation metrics like the Shiller P/E ratio are useful tools for gauging market risk, but they should be considered alongside other factors such as earnings growth, inflation, and monetary policy. Diversification remains one of the most effective ways to manage risk, as different asset classes and sectors often respond differently to economic shocks. Ultimately, the best defense against a bear market is a clear understanding of your financial goals, a realistic assessment of your risk tolerance, and a disciplined investment plan that can withstand both bull and bear cycles.
