The S&P 500 (SNPINDEX: ^GSPC) has soared by over 26% over the last 12 months, as of this writing, and it seems as if there’s little that can slow the market down. Even after a brief hiccup earlier this month, major indexes rebounded almost immediately and are now closing in on new record highs.
All this growth makes for an incredibly pricey market, however, and many investors are growing concerned that we’re in a bubble on the verge of popping.
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There’s one stock market indicator that sounded the alarm before both the Great Depression and the dot-com bubble burst, and it’s reaching historic levels yet again. Here’s what that might mean for your investments.
Is history repeating itself? Here’s what the data says.
The S&P 500 Shiller CAPE Ratio measures the S&P 500’s price against its inflation-adjusted earnings over the last 10 years, providing a snapshot of the index’s valuation over time. A higher metric suggests that the S&P 500 is becoming increasingly expensive and, in some cases, overvalued.
Throughout history, the CAPE ratio has averaged around 17. In the late 1920s, as the stock market crash and the Great Depression approached, it reached the mid-30s. It spiked again in 1999, reaching an all-time high of around 44 as dot-com stocks ballooned in value. As of this writing, the metric is just over 41.
While the ratio is currently at its second-highest level in history, that doesn’t necessarily mean a downturn is imminent. The tech stock boom has led to the normalization of higher valuations, and there’s a distinction between a high valuation and being overvalued.
High valuations themselves aren’t necessarily dangerous. Overvalued stocks, on the other hand, are those whose prices no longer match the company’s underlying fundamentals, and those companies risk crashing hard during the next market pullback.
Warren Buffett’s advice for moments like this
Warren Buffett recently commented on this historically pricey market during an interview with CNBC ahead of Berkshire Hathaway‘s annual meeting.
Buffett has long compared the stock market to a church with a casino attached, with one representing slow-but-steady long-term investing and the other short-term risk-taking. He noted during the interview that lately, “the casino has gotten very attractive to people.”
