Why the Stock Market Crash Odds Are Increasing
If you invest in stocks, 2025 hasn’t been that great for you so far. The stock market started the year out solid, but then volatility came in. Now key stock indices like the S&P 500 are down year to date and down roughly seven percent from its highs in February. With all this, one could be wondering if a big stock market crash is brewing.
Put simply: yes, it’s possible we’ll see a stock market crash in 2025.
In order for the stock market to sell off, there are three key elements that must occur: sour investor sentiment; high/unreal valuations; and some kind of catalyst to push investors to act and sell.
Stock Market Crash Signal #1: Investor Sentiment
So far, investor sentiment is turning sour.
Take a look at the chart below. It plots the percentage of bullish responses to the American Association of Individual Investors (AAII) Sentiment Survey. On a weekly basis, this survey asks individual investors where they see the stock market going in the next six months. In its most recent reading, close to 60.6% of all respondents were bearish.
This is the highest bearish figure for this survey in two years, and it has been trending upwards over the past few months. The historical average of bearish responses is around 31%, so the current reading is almost 100% above the historical average.
Chart Courtesy of StockCharts.com
Stock Market Crash Signal #2: Valuations
Now let’s take a look at the valuations; they are extremely high.
The forward 12-month price-to-earnings (P/E) ratio for the S&P 500 currently stands at 21.2. This P/E ratio is above the five-year average of 19.8 and 10-year average of 18.3. (Source: “Earnings Insight,” FactSet, February 28, 2025.)
Take a look at the cyclically adjusted price-to-earnings (CAPE) ratio. CAPE is essentially the P/E ratio adjusted for inflation and business cycles—a much better valuation measure.
At the end of February 2025, the stock market’s CAPE ratio is 37.33. (Source: “US Stock Market Data,” Shiller Data, last accessed March 5, 2025.)
Now, the CAPE ratio by itself doesn’t really mean much. You must compare it to the historical average, and how it looked around previous stock market peaks and bottoms.
Looking at the average CAPE ratio of the stock market since 2010, you’ll see it’s around 28. This means that the stock market is trading 35% above its long-term CAPE ratio.
The last time the CAPE ratio was this high was around mid-2021. Prior to that, the only time this ratio was at these levels was during the tech bubble of the late 1990s and early 2000s.
Stock Market Crash Signal #3: The Catalyst
Now, the big question: since two of three factors needed for a stock market crash are present, what could be the catalyst that induces selling (i.e. the third factor)?
There are three potential triggers worth watching.
- Tariffs: President Donald Trump’s tariff fiasco has the ability to force investors to think twice before investing. It could also force investors to readjust their portfolios, sending them fleeing from risky assets like stocks to safe-haven assets like bonds, causing a robust sell-off on the stock market in the process.
- Stagflation: We know that inflation expectations are starting to grow, and the U.S. economy is starting to show signs of cracking. In economic terms, this is called stagflation. Despite the Federal Reserve saying that there’s no such thing in sight, if stagflation starts to even become a possibility, investors could panic-sell and cause a stock market crash.
- Global Economy: While the U.S. economy might be fine for now, there are some significant risks of stagnation in the global economy. If there’s one thing that should be clear, it’s that the financial world is extremely interconnected. If the global economy starts sending “trouble” signals, investors could rush for the exits.
How Low Could the Stock Market Go?
Dear reader, the past few years have been fantastic in terms of the market, but the odds of a stock market crash are increasing now. Let me make it very clear that I am not rooting for a sell-off, nor is this is a recommendation to sell everything and sit on the sidelines.
My goal here is to warn you that the risks are increasing; this is not the time to be complacent.
How low could the stock market go if a stock market crash were to occur?
Don’t be shocked if indices like the S&P 500 drop 20% or even 30% from current levels in the event that investors start panicking.