Ben Gran, The Motley Fool
4 min read
Is now a good time to invest in stocks? Or is the stock market overheated, overpriced, and due for a big sell-off? The answer depends on your time horizon and overall financial goals. But some investors are worried about a widely respected valuation metric called the Shiller CAPE ratio. This metric keeps track of cyclically adjusted price-to-earnings for the S&P 500 index (SNPINDEX: ^GSPC).
The Shiller CAPE ratio uses stock market data going back to 1871. During the past 155 years, it has only peaked above 30 on five occasions. Several of those peaks happened right before big stock market downturns:
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1929 — right before the Great Depression
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1999 — right before the bursting of the dot-com bubble
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October 2021 — right before the 2022 bear market
S&P 500 Shiller CAPE Ratio data by YCharts.
As of this writing, the Shiller CAPE ratio had reached 41.8. That’s its second-highest level of all time, higher than any time since 1999. Does this mean stocks are due for a crash?
Not necessarily. No single valuation metric is 100% correct, and no way of looking at the stock market has a perfect track record of predicting the future. The S&P 500 moves up and down for all kinds of complex reasons.
The Shiller CAPE ratio is worth knowing about. But it doesn’t mean you have to make big changes in your investment allocations. Let’s see what the Shiller CAPE ratio could mean for your stock portfolio.
Why the Shiller CAPE ratio matters (or not)
The Shiller CAPE ratio is well-respected by stock market analysts because it’s a way to compare the S&P 500 index’s valuation across long-term time frames. The CAPE ratio effectively “smooths out” the ups and downs of S&P 500 earnings due to changes in the business cycle, such as recessions, and adjusts company earnings per share for inflation.
However, there are a few reasons why the historical data-based approach of the CAPE ratio might not be the best way to predict future performance of the S&P 500 today. The CAPE ratio doesn’t include stock buybacks. It also uses Generally Accepted Accounting Principles (GAAP) earnings, and GAAP standards have changed a lot since 1871. Another big limitation of the CAPE ratio is that it looks at S&P 500 performance during the past 10 years — but today’s stock prices are forward-looking, based on expectations of future earnings.
