The last time the S&P 500‘s Shiller cyclically adjusted P/E ratio was as high as it is now, it was August 2000. The S&P 500 was sitting near an all-time high of around 1,500, in the wake of a five-plus-year bull market.
At the time, the Shiller ratio — which gauges the 10-year inflation-adjusted valuation of the S&P 500 — was at 41.89, down from an all-time peak of 44.19 in November 1999. What was unclear at that point was that the market was already at the beginning of a bear market that would last until November 2022.
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Today, the Shiller P/E ratio is at about 41. That is the highest it has been since August 2000. Does that mean another bear market is imminent or that we are already at the start of one, as we were the last time the Shiller P/E was this high?
That’s impossible to know for now. For all we know, the market could keep charging ahead into the fifth year of a bull market.
Either way, investors should apply the same discipline. They should be looking to build a diversified all-weather portfolio and take any downturn as an opportunity to buy — not sell.
A bear market strategy
My approach in this type of market, where the large-cap index is overvalued and the economy is facing significant challenges, is to make sure my portfolio is adequately diversified.
If your portfolio has become top-heavy in tech stocks due to a four-year bull market that was largely powered by tech sector growth, you may want to make sure you rebalance it appropriately. I look for stocks that have become overvalued, meaning their valuation metrics are well outside of their typical average ranges, and I scale my positions in them back.
I also look to make sure I am adequately diversified with stocks and exchange-traded funds (ETFs) that tend to perform well when the broader market doesn’t. This may include value stocks, dividend stocks, and stocks of high-quality, well-capitalized companies that generate stable, sturdy earnings in any type of market or economy.
In addition, I look for bargains, especially among tech stocks, AI stocks, or growth stocks that are trading at discounted levels, perhaps victims of broader market sell-offs. If they are market leaders with strong earnings potential and are trading below their historical P/E ratios, then they might be great options to buy on the dip.
It is important to do some additional research on why any given stock is trading at a discount, but if the company’s fundamentals are strong and its advantages remain intact, then investors should be looking to buy. Because years from now, you may find that some of your best long-term investments were bought during bear markets.
