Warren Buffett Issues a $177 Billion Alert to Investors -- Past Trends Indicate This Is What the Stock Market May Do Next

The S&P 500 ( ^GSPC 0.59%) experienced a sharp decline after President Trump introduced broad tariffs in April. However, the index has since surged 33% from its lowest point and is now close to achieving positive returns for a fifth month in a row.

The economy has demonstrated more strength than many investors originally anticipated, and S&P 500 companies reported stronger-than-expected earnings in both the first and second quarters. Still, Warren Buffett has recently issued a $177 billion caution to investors, and historical trends suggest the stock market may face challenges in the coming years.

Here are the key points you need to know.

Berkshire Hathaway has sold a net $177 billion in stocks over the past 11 quarters

Berkshire Hathaway ( BRK.A 0.59%) ( BRK.B 1.06%) controls over 180 subsidiaries across various sectors, with its insurance operations being the main contributor to its operating profits. Warren Buffett and his investment team utilize these funds to acquire businesses or invest in other companies, aiming to further boost earnings.

During the 2022 bear market, Berkshire was a net buyer, meaning it purchased more stocks than it sold. But after the market bottomed, the company shifted its approach and has now been a net seller for 11 consecutive quarters, with total net sales reaching $177 billion in that time.

This sends a strong signal to investors, especially when considering another detail: As of the second quarter, Berkshire held $344 billion in cash and U.S. Treasury bills. This indicates the company has significant liquidity, but Buffett has opted not to deploy it. The most plausible reason is that he sees few attractive opportunities due to high stock valuations.

The S&P 500 is trading at a high valuation that has historically led to negative 3-year returns

The cyclically adjusted price-to-earnings (CAPE) ratio helps assess whether stock indices—most commonly the S&P 500—are overpriced. Unlike the standard PE ratio, which compares current market value to earnings from the previous year, the CAPE ratio uses the average inflation-adjusted earnings from the last ten years to smooth out fluctuations in the economic cycle.

Over the past month, the S&P 500’s average CAPE ratio stood at 38, which is exceptionally high. Since 1957, the index has only seen a monthly CAPE ratio above 37 on 41 occasions out of 825 months. In other words, the CAPE ratio has exceeded 37 just about 5% of the time in its history.

Historically, the S&P 500 has underperformed following months when the CAPE ratio was above 37. The chart below illustrates the average returns over the following one, two, and three years.

Data source: Robert Shiller. Note: Returns are not annualized.

As the data shows, the S&P 500 has generally declined in the one, two, and three years following CAPE readings above 37. If the index follows historical patterns, it could fall 3% over the next year and remain down 14% after three years.

It’s important to note that no stock market prediction tool is flawless. There have been times when the S&P 500 delivered solid gains even after its monthly CAPE ratio surpassed 37. Still, the market is clearly expensive at present, so investors should pay close attention to valuations when considering stock purchases.

In fact, a machine learning model developed by Moody's estimates a 48% chance of a recession within the next year. This model, though recently created, has been back-tested to 1960 and has proven highly reliable: Every time the probability exceeded 50%, a recession followed, and it has accurately predicted every downturn during that span.

The bottom line for investors is that the economy remains somewhat fragile, with labor market weakness and the uncertain effects of President Trump's tariffs adding to the risks. Therefore, it’s wise to take a cautious approach when making investment choices in today’s market.