This Recession Indicator Just Triggered. Here's What Investors Should Do Now.
Key Points
The Shiller CAPE ratio has risen to 39.6.
The only time it's been higher was in the lead-up to the dot-com bubble bursting, back in March 2000.
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Is a recession imminent?
The only time anyone seems to agree on the answer to that question is when we're already in a recession (generally defined as two or more consecutive quarters of negative economic growth).
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But that hasn't stopped people from trying to read various economic indicators to determine if a recession is on the way, and a big one just triggered. Here's what happened, and what investors should do now.
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Approaching a record high
One of the most common tools for assessing a single company's valuation is the price-to-earnings (P/E) ratio. In 1988, economist Robert Shiller devised a method to calculate a cyclically adjusted P/E for the entire S&P 500. Dubbed the "Shiller CAPE ratio" (CAPE stands for "cyclically adjusted price-to-earnings"), it has been retroactively computed back to 1871. And that computation contained a big surprise.
Since 1871, the CAPE ratio has only risen above 24 six times. The first five times each occurred just prior to a major market downturn, including just before the Great Depression in 1929 and the Great Recession in 2008.
The sixth time is happening right now.
Today, the CAPE ratio is well above 24: It's at 39.6. The only time it's ever been higher was on the way to its all-time high of 44.2 in March 2000 -- just before the dot-com bubble burst, causing stocks to plummet.
That said, investors shouldn't panic-sell. While the CAPE ratio indicates that stocks in general are richly valued, it doesn't necessarily mean a recession, or even a bear market, is imminent. Remember that even during market downturns, investors who hold onto their stocks generally come out ahead of those who try to time the market.
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John Bromels has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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