S&P 500: A Bumpy Ride in 2022 and Beyond
Stock drop alert indicated by accuracy measure
Are you feeling the market's wild ride this year? Inflation, tight monetary policies, and crashing indices like the S&P 500 have everyone on tenterhooks. The Dow and Nasdaq are deep in the red since the beginning of the year, but investors see this as a chance to scoop up stocks at a discount.
But deciding when to jump in isn't easy. Get in too soon, and you risk a significant drop, get in too late, and you miss out on attractive entry points. Fear not! There's an indicator that's spot-on in predicting all five bear markets since the late 1800s and has a knack for pinning down the S&P 500's low points. It's known as the Shiller P/E ratio.
Unlike the regular P/E ratio that divides the price by the expected earnings of the current fiscal year, the Shiller P/E uses the average of inflation-adjusted earnings over the past ten years. And guess what? As The Motley Fool reported, the Shiller P/E for the S&P 500 has only surpassed and maintained a value of 30 during a bull market rally five times since the late 1800s. Each time, this was followed by a drop of at least 20 percent, or a bear market. For instance, before the dot-com bubble, the Shiller P/E hit an all-time high of 44.19. In 2022, it happened again—the Shiller P/E exceeded the value of 40 for the first time in two decades in early January.
While reaching or surpassing the value of 30 doesn't tell us the exact peak will be reached, it does suggest that a bear market could be on the horizon. For example, in the third quarter of 2020, the Shiller P/E surpassed the value of 30, but it took over a year to exceed 40 in early 2022.
Riding the Bear Market Wave with the Shiller P/E Ratio
The Shiller P/E isn't just a bellwether for bear markets; it also shows when bear markets will hit their lows. Before the mid-1990s, the Shiller P/E often moved between 5 and 25. However, since the 2000s, values between 20 and 40 have become more common thanks to easy monetary policies implemented by central banks. As The Motley Fool noted, the Shiller P/E has consistently found a low point around 22 after significant market setbacks, such as the dot-com bubble or the correction in Q4 2015, 2018, and during the 2020 Corona crisis.
As of recently, the Shiller P/E was hovering around 27.66. If it falls into its typical range around 22, that would point to a low point for the S&P 500 of approximately 2990 points.
On a historical note, the Shiller P/E ratio, or Cyclically Adjusted Price-to-Earnings ratio, is a popular assessment tool for long-term market valuations, developed by Robert Shiller. Over time, it has demonstrated its ability to forecast market downturns and rebounds, with higher ratios signaling lower long-term returns and lower ratios indicating higher returns. However, pinpointing exact lows or bottoms can be tricky due to the numerous factors that influence market dynamics.
- The Shiller P/E ratio, a long-term market valuation tool, has consistently found a low point around 22 after significant market setbacks like the dot-com bubble.
- As of recently, the Shiller P/E was hovering around 27.66, which, if it falls into its typical range, could indicate a low point for the S&P 500 of approximately 2990 points.
- Investors might find the Shiller P/E ratio useful in predicting bear markets and identifying low points in the market, like the S&P 500 index.
- In 2022, the Shiller P/E exceeded the value of 40 for the first time in two decades in early January, suggesting a potential bear market could be on the horizon for finance and investing, especially in the stock-market.
