The S&P 500's Shiller CAPE ratio has climbed above 41, a level the market has touched only once before: the dot-com era. History shows that expensive markets don't always crash, but the last time valuations sat this high, the Nasdaq lost 78% of its value before the damage ended.
The Shiller cyclically adjusted price-to-earnings ratio has exceeded 41 at the time of writing, according to Motley Fool. Since the 1880s, the ratio, which values the S&P 500 against a decade of inflation-adjusted earnings, has averaged about 18, and only during the dot-com era has it climbed higher than today's reading.
Even against a shorter window, the current level stands out. Over the last 30 years, the ratio has averaged about 29, well below where it sits now.
A high valuation doesn't guarantee a crash
An expensive market doesn't mean every stock in it is overpriced, but high valuations often coincide with speculative excess. When earnings expectations detach from underlying profits, investors leave little room for disappointment, and any threat to future growth can give the market the jitters.
The dot-com era offers the closest precedent
In the late 1990s, investors poured money into unprofitable tech companies while the Federal Reserve raised interest rates three times in 1999 and three more in 2000. The Nasdaq Composite peaked in March 2000. Higher rates combined with heavy stock selling then triggered a panic that erased 78% of its value by October 2002.
What history can't tell investors
History suggests a crash is possible, but it can't say when one might hit or how long any damage would last. The market could also avoid a crash entirely and instead undergo a correction, typically defined as a 10% drop from recent highs.
Investors worried about a pullback might revisit diversification across their holdings, since a downturn tends to hit some industries harder than others. Keeping some cash on hand could also help if a correction opens up buying opportunities later.
Source: Motley Fool
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