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There is no way to accurately predict what the market will do in the near term, but sometimes it can be helpful to look to history for guidance. Unfortunately for investors, two major stock market metrics indicate that a reversal may be on the way. Here’s what you need to know.
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I S&P 500 The Shiller CAPE ratio — or cyclically adjusted price-to-earnings ratio — measures the average adjusted earnings of the S&P 500 during inflation over the past 10 years. A higher ratio suggests that the S&P 500 may be headed lower, and historically, stock prices tend to decline after higher highs.
In 1999, for example, the S&P 500 Shiller CAPE average reached a record high of nearly 44. Tech stocks have soared in price in recent years, leading to the bursting of the dot-com bubble in the early 2000s. It rose again in late 2021, just before the market entered a bear market that would last for most of the next year.
As of this writing, the average is close to 40. This is the highest it has been since the dot-com bubble more than 25 years ago and is well above the long-term average of about 17.
Another popular market metric is the Buffett index, which also measures prices, but in a slightly different way than the Shiller CAPE Ratio.
The Buffett index measures the relationship between the total stock market value of all US stocks and the US gross domestic product (GDP). A high ratio suggests that the overall market may be overvalued, while a low ratio suggests that it is undervalued and a prime buying opportunity.
It was named after 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, “When the ratio gets close to 200% — as it did in 1999 and half of 2000 — you’re playing with fire.”
As of this writing, the Buffett index is up about 219%. Like the S&P 500 Shiller CAPE Ratio, it also rose sharply in late 2021, reaching nearly 193% before the 2022 bear market began.
