Keith Speights, The Motley Fool
5 min read
Investors could be in store for a fourth consecutive year of double-digit gains. The S&P 500 (SNPINDEX:^GSPC) is near its all-time high. What’s there to worry about? Perhaps more than meets the eye.
For one thing, the stock market is doing something seen only two times since 1871 — and both of those times ended badly. The White House’s actions further complicate matters. Is President Trump raising the risk of another stock market meltdown?
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Image source: Official White House Photo by Molly Riley.
What history shows about expensive markets
Economist Robert Shiller created the S&P 500 Shiller CAPE (cyclically adjusted price-to-earnings) ratio to smooth out short-term noise in market valuations. He decided to use a 10-year moving average of inflation-adjusted price-to-earnings ratios. And his valuation metric has been remarkably accurate in predicting significant stock market downturns.
The S&P 500 Shiller CAPE ratio has risen above 35 only twice previously over the past 155 years. The first time the ratio breached the threshold was in late 1999 and early 2000. Corporate earnings multiples had skyrocketed due to the internet boom of the 1990s.
Every student of stock market history knows what happened next. Roughly four years after former Federal Reserve Chair Alan Greenspan famously used the phrase “irrational exuberance,” the dot-com bubble burst. The S&P 500 and other major market indexes plunged. It took years for them to fully recover.
The next time the S&P 500 Shiller CAPE ratio topped 35 was in 2021. By the end of the year, the metric was above 38. Then the Fed began jacking up interest rates to fight soaring post-pandemic inflation. The stock market promptly sank, with the S&P 500 entering a bear market.
That leads us to today. The S&P 500 Shiller CAPE ratio now stands at slightly above 41. This is the highest level that Shiller’s valuation metric has reached since the peak of the dot-com bubble. If history repeats itself, another significant market downturn could be on the way.
S&P 500 Shiller CAPE Ratio data by YCharts
Are Trump’s policies making it worse?
President Trump has levied steep tariffs so far in his second term. When the U.S. Supreme Court struck down his tariffs under the International Emergency Economic Powers Act (IEEPA), Trump used other authorities to impose new tariffs.
