The Stock Market Is Repeating a Rare Historical Pattern, But History Has Good News for Investors

The past few years have seen strong returns from the S&P 500 index (SNPINDEX: ^GSPC), but one of the most important valuation metrics is flashing a big warning sign. The Shiller CAPE Ratio was developed to measure cyclically adjusted price-to-earnings ("CAPE") for the 500 largest publicly traded stocks in the U.S. market. Instead of standard P/E ratios, the CAPE ratio intends to create a consistent measurement of S&P 500 stock valuations across different timeframes and economic conditions -- including recessions.

No single metric is always 100% correct at predicting the future of the stock market. But the Shiller CAPE Ratio is raising some eyebrows among investors and analysts. As of September 19, the CAPE Ratio is at its highest level since the dot-com bubble. Prior to that, the highest level the CAPE ratio had ever reached was in 1929 -- in the last months before the "Roaring 20s" stock market boom turned into the Great Depression.

What should you do with your investments when the Shiller CAPE Ratio is "too high?" Well...most of the time, you might want to just stay put and keep investing. But if you're worried about the valuation of large-cap stocks in the S&P 500, and you want to make a change in how you invest, small-cap stocks could be worth considering.

Continue reading