After years of record-breaking growth, major market indexes have stagnated. The S&P 500 (SNPINDEX: ^GSPC) and the Dow Jones Industrial Average (DJINDICES: ^DJI) have each dipped by around 2% from their all-time highs, while the Nasdaq Composite (NASDAQINDEX: ^IXIC) has slipped by close to 6%.
Investors are also feeling conflicted about the future of the market. Nearly 46% of investors believe stock prices will fall over the next six months, according to the latest weekly survey from the American Association of Individual Investors, while 37% are bullish about the future, and the remaining 17% expect little change.
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While it’s impossible to predict how stocks will perform in the coming months, the market is sending a warning signal that has only been seen during the dot-com bubble. Here’s how investors can prepare right now.
Is history repeating itself right now?
In the late 1990s, tech stocks were booming as excitement about the internet reached fever pitch. Many tech companies saw record-breaking initial public offerings (IPOs), reaching valuations that were astronomical for the time. Between 1995 and 1999 alone, the S&P 500 soared by close to 200%.
Another metric that was reaching record highs, though, was the S&P 500 Shiller cyclically adjusted price-to-earnings (CAPE) ratio. This ratio measures the S&P 500’s long-term valuation, with higher figures suggesting that the index is overvalued.
Historically, higher ratios have been followed by a drop in stock prices, and this metric has predicted market crashes such as the 1929 Great Depression. In early 1999, the ratio surpassed 40 for the first time in history as the dot-com bubble grew. Just over a year later, in March 2000, the bear market officially began.
Shiller CAPE Ratio data by YCharts
Now the CAPE ratio is elevated again. The metric surpassed 40 in May of this year, where it’s remained ever since. This is only the second time in history that it’s stayed this high for months at a time.
To be clear, this doesn’t necessarily mean we’re headed toward a dot-com-style crash. This metric provides a snapshot of the market’s valuation over time, but it can’t predict when the next bear market will begin, how severe it might be, or how long it might last.
That said, it does suggest that stocks are incredibly richly valued, making this the priciest market in decades.
