The S&P 500 Is Trading at a Valuation Not Seen in a Generation. History Has 1 Very Specific Lesson for Investors.
Key Points
Based on the Shiller P/E ratio, the S&P 500 is as expensive as it has been since the dot-com bubble.
Bear markets are an inevitable part of the stock market cycle, but their severity varies.
Investors should focus on staying consistent with their investments rather than trying to time the market.
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The S&P 500 (SNPINDEX: ^GSPC) is the stock market's most important index. That's why the three largest ETFs by assets under management (AUM) are all S&P 500 ETFs, with around $2.7 trillion in AUM as of Sept. 11.
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The S&P 500 has been on a great run over the past few years, more than doubling in value since the start of 2023. On one hand, that's an impressive feat for an index as diversified as the S&P 500. On the other hand, the S&P 500 is now sitting at a valuation we haven't seen in decades.
So, with valuations at record levels, what lesson should investors take away? It's not if the market will eventually pull back -- it's when.
Image source: Getty Images.
Just how expensive is the S&P 500?
One way to gauge how expensive the S&P 500 is is by looking at the Shiller price-to-earnings (P/E) ratio, which is also known as the cyclically adjusted P/E (CAPE) ratio. It's calculated by dividing the S&P 500's current level by the average inflation-adjusted earnings over the past 10 years.
At the time of writing, the S&P 500's CAPE ratio is 40.7, the highest since the dot-com bubble, when it peaked at 44.2 in November 1999. Unfortunately, the S&P 500's value was nearly halved after the dot-com bubble burst, so that isn't particularly encouraging.
The situations are very different -- with the artificial intelligence boom fueling the current run and pure speculation on unproven internet businesses fueling the dot-com bubble -- but it's worth keeping the historical perspective.
Bear markets are inevitable
The S&P 500 officially hits bear market territory when it has dropped by 20% or more from recent highs. And for better or worse, they're an inevitable part of the stock market cycle. How long they last and how much the S&P 500 drops vary widely, but you can be sure bear markets will happen.
The good news is they're typically much shorter than bull markets. For reference, below are the past 20 bull and bear markets.
| Bull or Bear Market | Date Range | Number of Days |
|---|---|---|
| Bull | Oct. 12, 2022 to Present | 1,430+ |
| Bear | Jan. 3, 2022 to Oct. 12, 2022 | 282 |
| Bull | March 23, 2020 to Jan. 3, 2022 | 651 |
| Bear | Feb. 19, 2020 to March 23, 2020 | 33 |
| Bull | March 9, 2009 to Feb. 19, 2020 | 3,999 |
| Bear | Oct. 9, 2007 to March 9, 2009 | 517 |
| Bull | Oct. 9, 2002 to Oct. 9, 2007 | 1,826 |
| Bear | March 24, 2000 to Oct. 9, 2002 | 929 |
| Bull | Oct. 11, 1990 to March 24, 2000 | 3,452 |
| Bear | July 16, 1990 to Oct. 11, 1990 | 87 |
| Bull | Dec. 4, 1987 to Jul. 16, 1990 | 955 |
| Bear | Aug. 25, 1987 to Dec. 4, 1987 | 101 |
| Bull | Aug. 12, 1982 to Aug. 25, 1987 | 1,839 |
| Bear | Nov. 28, 1980 to Aug. 12, 1982 | 622 |
| Bull | April 21, 1980 to Nov. 28, 1980 | 221 |
| Bear | Feb. 13, 1980 to April 21, 1980 | 68 |
| Bull | March 6, 1978 to Feb. 13, 1980 | 709 |
| Bear | Sep. 21, 1976 to March 6, 1978 | 531 |
| Bull | Oct. 3, 1974 to Sep. 21, 1976 | 719 |
| Bear | Jan. 11, 1973 to Oct. 3, 1974 | 630 |
Data source: Yardeni Research.
Bear markets don't typically put smiles on investors' faces, but they're a necessary evil, mainly to reset valuations and ground overly optimistic investor expectations. In long bull markets, stock valuations can often stretch beyond fundamentals, which many believe is the case now as AI has sent major tech companies' valuations skyrocketing.
Apple became the first trillion-dollar company on Aug. 2, 2018, and now 14 public companies are worth at least a trillion, two are worth $4 trillion, and Nvidia is worth $5 trillion (as of market close on Sept. 11). That isn't inherently bad, but at some point, you have to wonder how much is speculation-based.
Stay the course
Nobody can predict when the next bear market will happen. It could be days, weeks, months, or years. This isn't to sound the alarm about an immediate bear market. More than anything, it's about mentally preparing for what could happen.
No matter when it happens, history shows the best thing investors can do is keep investing and resist the urge to time the market (in this case, avoiding investing because you expect a drop). Some investors may luck out and time it correctly, but consistency is a much better wealth-building strategy.
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Stefon Walters has positions in Apple. The Motley Fool has positions in and recommends Apple and Nvidia. The Motley Fool has a disclosure policy.
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