S&P 500 Has Only Been This Expensive One Other Time — At The Peak Of The Dot-Com Bubble

Economist Robert Shiller

By at least one popular investing metric, U.S. stocks have only been this expensive one other time in history, and it didn’t end well the first time around.

According to the cyclically adjusted price-to-earnings ratio — a measure of market value based on 10 years of smoothed earnings data — the S&P 500 is at its second most expensive point in history.

Related Link: Will Tesla Destabilize The S&P 500?

The S&P 500’s current CAPE of 34 has only been surpassed one other time, during the peak of the dot-com bubble in 2000. Today’s CAPE is more than double the S&P 500’s historical mean and significantly higher than its peak at around 30 just prior to the Black Tuesday market crash back in 1929.

Many investors still remember the painful fallout from the dot-com bubble. But just because the market is overvalued doesn’t necessarily mean it’s time to start selling or shorting the SPDR S&P 500 ETF Trust SPY.

Shiller’s Take:  Nobel Prize-winning economist Robert Shiller references the CAPE ratio as a measure of market valuation so often that it is commonly referred to as the “Shiller ratio.” In a recent interview with CNBC, Shiller said an expensive market doesn’t necessarily mean it’s time to dump stocks.

“The market is highly priced, but it’s not so high that I wouldn’t consider it as an investment,” Shiller said in December.

Shiller is known for his study of the psychology of investing, particularly during financial market bubbles.

While widespread coronavirus vaccinations will certainly be a fundamental change for the U.S. economy, Shiller said he is concerned about how quickly investors expect the economy to fully recover once the nation is vaccinated. He anticipates fears related to the virus will linger among American consumers for at least another year.

CAPE’s Shortcomings: Stock earnings have historically been discounted by a cost of capital that's tied to interest rates. Following an emergency rate cut in March, interest rates are now essentially at 0%.

“It makes no sense to compare 2020 to prior periods, at least as naively as the Shiller PE does, without acknowledging that 10-year Treasuries yield 1% now and were higher at any other point [in history],” DataTrek Research co-founder Nicholas Colas said Wednesday.

While CAPE certainly gives a relative indication of market valuation, it also hasn’t been the best indicator of when to buy and sell stocks. Since it incorporates a decade of earnings data, CAPE tends to be relatively slow-moving. Using CAPE alone, U.S. stocks still seemed expensive even after the bursting of the dot-com bubble and the 2008 financial crisis. On the other hand, CAPE has indicated stocks were pricey over the entirety of the past six years during one of the strongest bull markets in history.

Finally, Colas said the S&P 500 itself is much more tech-heavy than in any other point in history, an important dynamic to consider when looking at past valuations.

For example, in 1980, the energy sector represented 26% of the S&P 500 and the tech sector represented just 8%. Today, energy has a 2% weighting and tech has a 28% weighting. Colas said investors shouldn't lose sight of how much that type of composition shift can have on the index’s overall valuation.

“Every sector in the S&P 500 has its own fundamentals and therefore its own valuation,” he said.

Benzinga’s Take: Smart investors never ignore critical metrics like the CAPE ratio. But smart investors also know not to rely too heavily on one single metric. Investors must understand exactly how the numbers are calculated, what the numbers are and aren’t telling them, and what other pieces of information will complement those numbers to paint a full picture of what is happening in the market.

Photo by Bengt Nyman via Wikimedia.