The S&P 500 (^GSPC 0.01%) has climbed roughly 104% since the fall of 2022, and the Nasdaq-100 has done even better at 173%. Since the end of March alone, the indexes have added 17% and 29%, respectively. Runs like this tend to come with a feeling they can go on forever.
But that’s not how markets work, unfortunately. And for those paying attention, an important metric just crossed a line it’s only crossed once before in 150 years of market history — during the dotcom bubble.
The CAPE just hit 40
The metric in question is the cyclically adjusted price-to-earnings (CAPE) ratio. It’s also known as the Shiller P/E, after Nobel laureate Robert Shiller, who developed it. The CAPE divides the S&P 500‘s price by its average inflation-adjusted earnings over the prior 10 years. That decade of smoothing helps strip out near-term distortions, making it a useful zoomed-out read on whether stocks are cheap or expensive.
Image source: Getty Images.
Just last month, the CAPE crossed 40, a level it hasn’t reached since 1999 when it peaked at 44. What followed was the worst stock market crash in a generation, in which the S&P 500 fell roughly 50% and the Nasdaq lost about 78%.
So here’s the obvious question: Are we headed for a repeat?
How today’s market differs from 1999
First, there are some key ways in which today’s market differs from that of 1999. Most importantly, the companies that are leading the AI trade are cash-generating machines with fortress balance sheets. That wasn’t generally true in 1999.
Now, as for the metric itself, the truth is that while it has not passed 40 until now, the CAPE has been flashing red for years. It’s been well over 50% higher than the long-run median of 16 since 2012 and twice the average since 2020.
Why the Shiller P/E still matters
So why should you care? Because, while flawed, the CAPE is still a good indicator of long-term returns — the higher it is, generally the worse your returns are over the next decade. And in the near term, it helps contextualize the market.
A CAPE at record levels is not a guaranteed signal of an imminent crash, but it does say that where we are is unsustainable. At some point, this market will correct, and the higher the CAPE rises, the more precarious the situation becomes.
This means now is a good time to avoid chasing high-growth names with no earnings, and to consider stocks that are outside the world of tech and AI.
