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There’s no way to predict exactly what the market will do in the near term, but it can sometimes be helpful to look at history for guidance. Unfortunately for investors, two major stock market metrics are signaling that volatility could be on the way. Here’s what you need to know.
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The S&P 500 Shiller CAPE ratio — or cyclically adjusted price-to-earnings ratio — measures the S&P 500’s average inflation-adjusted earnings over the last 10 years. A higher ratio suggests the S&P 500 may be overvalued, and historically, stock prices tend to decline after a peak.
In 1999, for example, the S&P 500 Shiller CAPE ratio reached a record high of around 44. Tech stocks had ballooned in price in recent years, leading to the dot-com bubble burst in the early 2000s. It also peaked in late 2021, just before the market entered a bear market that would last most of the following year.
As of this writing, the ratio is close to 40. This is the highest it’s been since the dot-com bubble more than 25 years ago and significantly higher than the long-term average of around 17.
Another popular market metric is the Buffett indicator, which also measures valuations, but in a slightly different way than the Shiller CAPE Ratio.
The Buffett indicator measures the relationship between the total market cap of all U.S. stocks and U.S. gross domestic product (GDP). A higher ratio suggests the overall market may be overvalued, while a lower ratio implies it’s undervalued and a prime buying opportunity.
It was nicknamed for Warren Buffett after he used the metric to successfully predict that the dot-com bubble was about to turn into a bear market. Afterward, he explained in an interview that, “If the ratio approaches 200% — as it did in 1999 and a part of 2000 — you are playing with fire.”
As of this writing, the Buffett indicator is at around 219%. Like the S&P 500 Shiller CAPE Ratio, it also peaked in late 2021, reaching around 193% before the 2022 bear market began.
