Is this 2000 or 2022?
Valuations of American stocks have reached a level that the market has seen only twice in 156 years. Once, a crash by half followed; once, a quick correction. Which of these is approaching now won't be revealed by stocks, but by one number from a completely different market.
Key points
The Shiller P/E of the S&P 500 index has climbed to 41.60, something the market has seen only twice in 156 years of history.
Both previous episodes ended in a bear market, but one erased half the index and the other healed within a year and a half.
The decisive difference between 2000 and 2022 was not in stocks, but in a market most investors ignore.
A forward P/E of 19.2 claims the market is normally expensive, and it has one strong argument against the Shiller P/E.
The earnings yield of American stocks today is 5.2%; a ten-year government bond pays 5.23% without risk.
For the third time in 156 years – and two completely different endings
Wall Street is currently experiencing something that has happened only twice in the entire measurable history of the American stock market. The Shiller P/E of the S&P 500 – the price of stocks divided by the ten-year average of inflation-adjusted earnings – reached 41.60 as of September 21. The long-term average since 1871 is 17.42. The indicator has held above 40 only in 1999–2000, when it hit a record 44.19 in December 1999, then for a few days in January 2022, and continuously since this May.
Both previous episodes ended in a bear market. But that is the only thing they have in common. After the dot-com bubble burst, the S&P 500 lost 49% by October 2002 and the Nasdaq 78%, and it took two and a half years for the decline to stop. In 2022 came a 25% drop that ended in nine months, and the index returned to new highs within another year and a half.
For an investor holding cash today, looking at an index less than one percent below the August high, the difference between these two scenarios is fundamental. One means a lost decade; the other an unpleasant but quickly forgotten year. So asking merely "is the market expensive?" is not enough. The right question is: why did the same valuation lead once to a crash and once to a quick correction?