From April 2 to April 9, the benchmark S&P 500 (^GSPC -0.33%) experienced one of its most dramatic weeks in recent memory. It suffered its fifth-steepest two-day percentage decline in 75 years, yet also logged its largest single-day point gain since inception. On April 9 alone, the Dow Jones Industrial Average (^DJI -0.63%) and Nasdaq Composite (^IXIC -0.22%) recorded their largest single-session point gains ever.
As a result, the S&P 500 and Dow fell into correction territory, and the Nasdaq entered its first bear market since 2022.
But then, the tide shifted.
In the three months following their April 8 bottom, the S&P 500 and Nasdaq Composite surged to all-time highs, and the Dow isn’t far behind. On the surface, Wall Street appears stronger than ever.
The Shiller P/E Ratio: A Perfect Predictor Signals Trouble
While all looks well, one historically flawless stock market predictor is nearing a dangerous milestone. This predictive tool has a 100% success rate in forecasting future stock returns when back-tested over more than 150 years.
“With the above being said, the historically flawless forecasting tool that’s on the verge of making history — and not in a good way — is the S&P 500’s Shiller price-to-earnings (P/E) ratio, also known as the cyclically adjusted P/E ratio, or CAPE ratio.”
Unlike the traditional P/E ratio, the Shiller P/E uses inflation-adjusted earnings over the past 10 years, offering a more accurate long-term view.
As of July 10, the Shiller P/E stood at 38.26 — dangerously close to the 38.89 peak from December during the current bull run. While not yet at the record 44.19 from the dot-com bubble or the just-over-40 mark from January 2022, it’s still within striking distance of becoming the third-highest valuation in history across a continuous bull market, based on 154 years of back-tested data.
History Has Spoken: Every Time Above 30, a Crash Follows
“There have been only six unique instances, dating back to January 1871, where the S&P 500’s Shiller P/E ratio has surpassed 30 and held that mark for at least two months. Following the five prior occurrences, the Dow Jones, S&P 500, and/or Nasdaq Composite eventually plunged by 20% to 89%.”
This isn’t a timing tool — it won’t tell you when the fall will happen. The Great Depression saw the Shiller P/E dip below 30 very quickly. The dot-com bubble, on the other hand, kept it above 30 for over four years. Regardless of duration, the outcome has always been the same: sharp declines in equities.
“What this flawless predictive tool has demonstrated is an uncanny track record of foreshadowing significant downside in equities. It’s a harbinger of trouble for the stock market, and a multiple of 38.26 signals that valuations are extended and unsustainable.”
The Silver Lining Hidden in Bear Markets
While the Shiller P/E ratio warns of an incoming bear, there’s a historically optimistic outlook for investors who stay the course.
“In June 2023, with the S&P 500 having risen 20% from its October 2022 bear market bottom, the benchmark index was officially in a new bull market. That’s when analysts at Bespoke Investment Group published a data set on X (formerly Twitter) that compared the calendar-day length of every S&P 500 bull and bear market dating back to the start of the Great Depression in September 1929.”
Here’s what they found:
- The average bear market lasts just 286 calendar days
- None of the 27 historical bear markets lasted longer than 630 days
- In contrast, the average bull market runs for 1,011 calendar days — nearly 3.5 times longer
So, even if a downturn is near, the recovery is likely to last much longer — and bring significant gains with it.
Also Read: Bill Ackman Drops One-Word Take on Markets as Stocks Defy Economic Warnings
Think Long-Term: Buy the Dip
“What all this data implies is that bear markets tend to be short-lived and are surefire buying opportunities for investors with an optimistic, long-term mindset.”
Just as the Shiller P/E warns of near-term pain, over a century of stock market data shows that the major indexes rise over time. For long-term investors, the next dip might be a perfect time to buy high-quality stocks or broad-market ETFs at a discount.
One Last Thing Before You Buy the S&P 500
“Before you buy shares in the S&P 500 Index, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and the S&P 500 Index wasn’t one of them.”
Their past picks — like Netflix and Nvidia — turned $1,000 investments into hundreds of thousands or even over a million dollars.
“The stocks on today’s list could have similar growth potential!”
So, while the S&P 500 might not be the safest short-term bet according to the Shiller P/E, the long-term reward is there for those who stay alert — and invest wisely.
Source: Motley Fool