The S&P 500's Shiller CAPE ratio is climbing toward a level reached in only one prior stretch: the 1999-2000 dot-com peak. The Motley Fool says the reading invites caution, since elevated valuations have historically preceded weaker returns.
The S&P 500's cyclically adjusted price-to-earnings ratio is inching closer to its dot-com-era highs, a level the market has touched only once before. That comparison is what makes the current reading unsettling for long-term investors.
A valuation gauge built to cut through noise
The CAPE ratio divides the current level of the S&P 500 by the average of inflation-adjusted earnings over the past 10 years. Because it smooths a decade of profits, it strips out the distortions that can make an ordinary price-to-earnings ratio look artificially high or low in a single year.
When the reading climbs, it usually signals that prices are rising faster than underlying earnings. Over the long run, higher CAPE readings have been followed by more modest stock returns, because frothy markets leave less room for further multiple expansion.
The only prior match was the dot-com peak
Historical annual averages show the CAPE ratio reached or surpassed 40 for consecutive years only once: in 1999 and 2000, when it hit 42.1 and 41.7. Those readings came during the height of dot-com euphoria, as investors poured capital into internet start-ups and established technology companies alike.
The unwinding that followed was severe. Beginning in 2000, the Nasdaq fell more than 75% from its peak and the S&P 500 entered a bear market that lasted into 2002.
What the signal does and does not say
The current CAPE ratio has not yet matched those extremes, which is why the Fool frames the elevated level as an invitation to caution. A continued rise could foreshadow weaker total returns or a meaningful drawdown, though such outcomes are never certain.
Instead of trying to time the market, the article suggests investors lean on broad diversification across sectors and asset classes.
Source: The Motley Fool
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