For the better part of the last 17 years, Wall Street can do no wrong. Though there have been short-lived periods of uncertainty and volatility, optimists have ruled the roost and propelled the Dow Jones Industrial Average (DJINDICES:^DJI), S&P 500 (SNPINDEX:^GSPC), and Nasdaq Composite (NASDAQINDEX:^IXIC) to new heights.
More recently, the evolution of artificial intelligence, better-than-expected corporate earnings, record S&P 500 share buybacks, and historic initial public offering activity have been the stock market’s primary catalysts.
Missed Nvidia in 2009? This Rare Signal Is Flashing Again. In 2009, a “Double Down” signal flashed for a little-known chipmaker called Nvidia. For the first time in years, that same “Total Conviction” signal is flashing for a company 1/100th the size of Nvidia. Continue »
Nevertheless, history teaches us that bull markets aren’t indefinite. Although the Dow, S&P 500, and Nasdaq Composite have a knack for rising over multiple decades, stock market corrections and bear markets are par for the course when investing over the long term.
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While historical events can never guarantee what’s to come on Wall Street, they do, more often than not, have an uncanny ability to foreshadow the future. One such ultra-rare event is occurring right now, for only the third time since the early 1870s, and it bodes poorly for Wall Street.
The stock market has reached a level observed only three times since January 1871
Make no mistake about it, there are always catalysts capable of turning the stock market on its proverbial head. For instance, historical precedent shows that parabolic moves in outstanding margin debt are a harbinger of downside for stocks.
However, no headwind is screaming louder at the moment than historically high stock valuations.
What makes valuing stocks so tricky is the lack of a blueprint. Since there isn’t a one-size-fits-all way to evaluate and value all businesses or the broader market, stock valuations will always entail some degree of subjectivity and/or emotion. This subjectivity is one of the core reasons why short-term directional moves in the Dow, S&P 500, and Nasdaq Composite are virtually impossible to predict with ongoing accuracy.
But there is a valuation measure, introduced by economists in the late 1980s, that can cut through this emotion and subjectivity to provide apples-to-apples valuation comparisons across the broader market. I’m talking about the S&P 500’s Shiller Price-to-Earnings (P/E) Ratio, also known as the Cyclically Adjusted P/E Ratio (CAPE Ratio).
