Article by Shawn Tully in Fortune
On July 12, the S&P 500 posted a new all-time record close of 4385, extending its gains since the start of 2021 to 16.8%. But the market reached another milestone that should gravely concern prudent investors. A highly respected valuation gauge developed by Yale economist and Nobel laureate Robert Shiller hit a mark showing that the S&P 500 is now pricier than in 96% of all quarters over the past 141 years. Put differently, big-cap stocks have been this expensive only 4% of the time in the recorded history of equity markets.
The new reading is so extreme that it suggests stocks may be soaring in a speculative frenzy unhinged from fundamentals. It also spotlights the bulls’ view that the current regime of super-slim interest rates means that big-caps can sustain, or even expand, price/earnings (P/E) multiples virtually never before seen. The Shiller data points to a different outcome: Just because equities are likely to beat ultra-low-yielding Treasuries in the years ahead, doesn’t mean stocks will keep delivering strong gains. Quite the contrary: The data suggests that Treasuries will do extremely poorly, and the S&P should underperform as well.
U.S. big-caps will battle three powerful headwinds. First, the fall in “real” rates that has done so much to lift valuations, will inevitably reverse. Second, that downdraft pressures today’s high-flying P/E multiples. Third, the U.S. economy is destined to grow at a far slower pace than in recent decades, reducing profit gains from stupendous before the pandemic to slim in the years ahead. Since mid-2020, it’s been all about momentum. Going forward it will be all about the other Big M—the market Math.
At the close of 4385 on July 12, the CAPE reached 38.39. To put that number in perspective, the reading just prior to the stock market crash of 1929 was one-sixth lower, at 32.56. In the 141 years for which Shiller has been measuring the CAPE, it exceeded 38.39 only in a single period: The “tech bubble” of late 1998 through 2000.
The CAPE fell below 40 in late 2000, and never again attained 38.39 until July 12.
In the past, what follows after the CAPE gets this lofty isn’t pretty. Put simply, a CAPE well over 38 is an off-the-charts outlier that, the single previous time it happened, led to ……
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