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Shiller PE Ratio Hits Rare 40: Warning Sign?
2 Oct
Summary
- Shiller PE Ratio, a measure of market valuation, has surpassed 40.
- This rare level was last seen before the dot-com bubble burst.
- US stock prices have outpaced earnings growth, inflating the ratio.
The Cyclically Adjusted Price-to-Earnings (CAPE) Ratio, also known as the Shiller PE Ratio, has now exceeded 40. This valuation level is exceptionally rare, having previously occurred only at the peak of the dot-com bubble before its subsequent crash. It also matches current market conditions, signaling potential investor caution.
The CAPE ratio accounts for inflation over the past decade, smoothing earnings to provide a more stable valuation metric. Its current surge indicates that stock prices have risen faster than corporate earnings. For instance, the Nasdaq Composite has seen over 26% annualized returns since October 2023, and the S&P 500 has grown at a 21% CAGR during the last three years.
While a strong earnings season is anticipated with full-year S&P 500 earnings projected to increase by 35%, concerns linger about sustaining this growth. Projections suggest a moderation in US corporate profit growth by 2027, with a 15% increase expected, a notable deceleration. This slowdown is partly attributed to moderating AI capital spending.
Historically, a high CAPE ratio has served as a warning. In 2000, after the ratio reached 44, the market experienced a nearly 50% crash over subsequent years. Although the current ratio of 41 does not guarantee an immediate crash, it highlights extremely high market valuations. Investors' current willingness to hold stocks at these levels assumes continued earnings growth, a premise that warrants careful consideration and potential portfolio adjustments.
