There is a deep and growing rift between market optimists and pessimists regarding the overall health of the US equity market, with the two camps holding sharply opposed views. Optimists envision further substantial gains driven by exceptional corporate performance and technological advancements; pessimists warn of a speculative bubble inflated by enthusiasm for artificial intelligence. Both perspectives miss the mark.

This debate would be little more than idle chatter if not for the substantial capital involved. A vast number of Americans hold stocks, and many closely track market movements and financial commentary. Frequent predictions of an imminent downturn, which are plentiful nowadays, could persuade investors to withdraw funds or postpone new investments, a move that is seldom wise. Conversely, overstating the market's realistic potential is a surefire way to disappoint investors and may lure them into pursuing even greater returns from promising but speculative AI-focused individual stocks.

The most probable scenario ahead is neither unending gains nor an abrupt crash, but rather a healthy, transient pullback in both corporate profits and the stock market. A long look at market history strongly supports this view.

The magnitude of this disagreement is apparent in the starkly different market valuations calculated by each side.

Optimists, referencing a sustained period of upward earnings revisions and anticipated profit growth of 32% for the S&P 500 this year, point to a somewhat elevated forward price-to-earnings ratio of 19 times. Pessimists, who prefer not to count profits before they materialize, rely on a longer-term metric, typically a 10-year average of reported earnings adjusted for inflation, known as the cyclically adjusted price-to-earnings ratio. This method yields a more concerning P/E ratio of 40 times. The disparity between these two metrics is the largest ever recorded since 1990, the first year for which earnings projections are available.

This gap is fueled by the recent surge in profitability. S&P 500 earnings have climbed 25% over the past year and 14% annually over the last three years, significantly outpacing the historical average growth rate of roughly 7% per year since the 1950s. They have also exceeded the growth in cyclically adjusted earnings by 15 percentage points in the last year and 6 percentage points annually over three years.

Wall Street analysts often project future trends based on recent performance, which explains the optimistic outlook and the wide chasm between valuations based on projected versus historical earnings.

The challenge for the optimists is that the S&P 500 has never sustained double-digit profit growth. A slowdown is inevitable, and it may occur sooner rather than later, as the number of companies contributing to S&P 500 earnings growth is anticipated to diminish. This points to lower returns in the future, despite the bulls' hopeful stance.

It also likely signals lower earnings in the near term. Since the 1870s, the S&P 500 and its predecessor index have reported year-over-year earnings growth in the double digits on 35 separate occasions. The typical period of double-digit (or near-double-digit) growth has lasted about 23 months. Notably, in all but two of those instances, this growth was followed by a decline in earnings. In those cases, year-over-year growth gradually faded over a few months before turning negative, with the subsequent declines lasting an average of 20 months. The current growth streak has already reached 33 months and is still ongoing.

Earnings downturns are almost always linked to lower stock prices, but there is no reason to anticipate a market crash. The average peak-to-trough price decline for the S&P 500 during those 33 instances was 24%, representing a mild—and always temporary—bear market. The deepest earnings recessions and accompanying market falls in recent history have been tied to major crises, such as the 2008 financial crisis and the 1973 oil crisis, rather than ordinary shifts in the profit cycle.

No one can predict if or when a crisis might occur, so there is no point in trying to foresee one. While asset bubbles can trigger an earnings recession, as the dotcom collapse did in the early 2000s, this situation is different. A bubble represents a disconnect between price and tangible value; the S&P 500 is not inexpensive, but its valuation is not unreasonable for a market driven by some of the most innovative, impactful, and profitable companies ever created.

Understanding historical patterns won't help investors time the turns in the profit cycle. The market typically anticipates earnings reversals well before they appear on corporate financial statements. In nearly every case, the market started to decline while earnings were still rising, and conversely, it began to climb even as earnings continued to fall. In essence, the market itself will signal when this extraordinary period of earnings growth has come to an end.

You might question whether the S&P 500's recent dip is such a signal. Probably not. For one thing, September is traditionally the index's weakest month, so the recent downturn is not out of the ordinary. Furthermore, the index is only down 1% from its August peak. I generally don't pay serious attention unless the market falls by at least 10%, and it only becomes a significant earnings concern if the index drops closer to 20%. Stay tuned.

The record of earnings cycles remains useful for understanding what to anticipate, even if not exactly when. It suggests that this earnings boom will most likely conclude with a period of temporarily reduced profits, disappointing the optimists, but it will probably stop short of a full-blown market collapse, much to the pessimists' relief.