For the better part of the last 2.5 years, optimists have ruled the roost on Wall Street, with all three major stock indexes -- the Dow Jones Industrial Average (^DJI 0.52%), S&P 500 (^GSPC 0.55%), and Nasdaq Composite (^IXIC 0.70%) -- climbing to fresh record-closing highs.

Catalysts have been aplenty, with everything from an uptick in share buybacks to the rise of artificial intelligence (AI) lifting equities. But sooner or later, history teaches investors that the stock market doesn't move up in a straight line.

Image source: Getty Images.

On Feb. 19, the growth stock fueled Nasdaq Composite, which has led the current bull market higher, hit an intraday high of 20,099.39, which is around 100 points below its all-time intraday high achieved in mid-December. Just nine sessions later, on March 4, the Nasdaq would trough at 17,956.60 on an intraday basis. In less than two weeks, the Nasdaq dived by close to 11%, using intraday figures.

Let's take a brief look at Wall Street's downside catalysts and lean on history to determine how far the Nasdaq Composite can fall.

Tariff talk becomes taxing to investors

At any given time, the stock market has at least one data point, predictive tool, or potential news event that acts as a possible downside catalyst. Right now, two factors stand head and shoulders above the others as having the ability to push stocks lower.

Recently, the most front and center of these issues is the uncertainty surrounding President Donald Trump's tariffs.

Tariffs are a tax placed on goods imported into the U.S., with the goal being to protect U.S. jobs and make domestically manufactured goods more price competitive with those being brought in from overseas. While tariff talk from the Trump administration has been fluid, tariffs on select imports are currently in place for Canada, Mexico, and China, as of this writing on March 5.

Image source: Getty Images.

One of the factors that make tariffs a possibly worrisome proposition is their historic correlation with downside for stocks. Based on a report from Liberty Street Economics, which publishes in-depth analyses for the Federal Reserve Bank of New York, stocks that were exposed to President Trump's tariffs on China in 2018 and 2019 performed notably worse on tariff announcement days than public companies that weren't exposed.

The other concern is that tariffs don't always have their intended effect. Output tariffs, which are taxes placed on finished goods being imported into the U.S., do have the potential to make American-made goods more price competitive. But tariffs placed on goods used in the production of American-made items (known as input tariffs) often make domestic manufacturing more expensive.

The stock market is historically pricey -- and that's a problem

The second variable that's at least somewhat responsible for the Nasdaq diving almost 11% in nine sessions is the historically pricey status of equities.

The best-known measure of value on Wall Street is the price-to-earnings ratio (P/E), which divides a company's share price by its trailing-12-month earnings per share (EPS). The P/E ratio offers a quick and easy way to size up mature businesses, but it's not always the most efficient valuation measure for growth stocks.

The valuation tool that offers true apples-to-apples comparisons is the S&P 500's Shiller P/E Ratio, which is also known as the cyclically adjusted P/E ratio (CAPE Ratio). Unlike the traditional P/E ratio, the Shiller P/E is based on average inflation-adjusted EPS over the last 10 years. Examining a decades' worth of earnings data helps to smooth out the peaks and valleys associated with shock events.

S&P 500 Shiller CAPE Ratio data by YCharts.

When the closing bell tolled on March 5, the S&P 500's Shiller P/E ratio stood at 36.80. To offer context, this is more than double its average multiple of 17.21, when back-tested to January 1871, and it represents the third-highest Shiller P/E reading during a continuous bull market rally, dating back 154 years.

Including the present, there have only been a half-dozen times since 1871 where the S&P 500's Shiller P/E has surpassed 30 and held that mark for at least two months. The previous five occurrences were all eventually followed by declines in the S&P 500, Dow Jones, and/or Nasdaq Composite of at least 20%.

But what's particularly noteworthy about the Shiller P/E is where it has bottomed out in the modern era (i.e., since the internet went mainstream). When valuations have previously become extended to the upside, the Shiller P/E has often retraced to a low of around 22.

During the current bull market cycle, the high for the Shiller P/E was almost 39 (set in December 2024). If the Shiller P/E were to plunge to 22, the Nasdaq Composite would ultimately lose in the neighborhood of 40% of its value. This would imply a low of around 12,000 for this growth stock driven index.

There's an important difference between "time in" and "timing" the stock market

Based solely on historic precedent, which includes the performance of stocks following the implementation of tariffs under President Trump, as well as the pricey level of the broader market, there's a real possibility the Nasdaq Composite's move lower is just getting started.

But as an investor, it's crucial to understand the difference between trying to time short-term directional moves in the stock market and allowing your money to spend time in the market.

On one hand, stock market corrections, bear markets, and even crashes are normal, healthy, and inevitable aspects of the investing cycle. On the other hand, decisive moves lower on Wall Street tend to be short-lived.

It's official. A new bull market is confirmed.The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp

-- Bespoke (@bespokeinvest) June 8, 2023

In June 2023, the analysts at Bespoke Investment Group published a data set on social media platform X that compared the length of every bull and bear market in the S&P 500 dating back to the start of the Great Depression in September 1929. Even though this data set is coming up on being two years old, it provides the perspective investors need when putting their money to work on Wall Street.

Spanning 94 years, there were 27 separate bear and bull markets. Whereas the typical bear market endured for an average of 286 calendar days (9.5 months), the average bull market stuck around for 1,011 calendar days, or roughly two years and nine months.

Furthermore, Bespoke's data set clearly showed that roughly half of all S&P 500 bull markets have lasted longer than the lengthiest bear market since the Great Depression.

Even though we're never going to know ahead of time when stock market downturns will begin, how long they'll last, or where the bottom will be, history decisively shows that time in the market pays off handsomely for patient investors.