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There is no way to predict exactly what the market will do in the short term, but sometimes it can be helpful to look at history for guidance. Unfortunately for investors, two important stock market metrics indicate that volatility could be on the way. Here’s what you need to know.
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He S&P 500 The Shiller CAPE ratio, or cyclically adjusted price-earnings ratio, measures the inflation-adjusted average earnings of the S&P 500 over the past 10 years. A higher ratio suggests that the S&P 500 may be overvalued, and historically, stock prices tend to fall after a peak.
In 1999, for example, the S&P 500’s Shiller CAPE ratio reached an all-time high of around 44. Tech stock prices had skyrocketed in recent years, leading to the bursting of the dot-com bubble in the early 2000s. It also peaked in late 2021, just before the market entered a bear market that would last most of the following year.
At the time of writing, the ratio is close to 40. This is the highest since the dotcom bubble more than 25 years ago and significantly higher than the long-term average of around 17.
Another popular market metric is the Buffett Indicator, which also measures valuations, but in a slightly different way than the Shiller CAPE Ratio.
The Buffett Indicator measures the relationship between the total market capitalization of all US stocks and the US gross domestic product (GDP). A higher ratio suggests that the overall market may be overvalued, while a lower ratio implies that it is undervalued and an excellent buying opportunity.
It was nicknamed after Warren Buffett after he used the metric to successfully predict that the dotcom bubble was about to turn into a bear market. Later, he explained in an interview that “if the proportion approaches 200%, as happened in 1999 and part of 2000, you are playing with fire.”
At the time of writing, Buffett’s indicator stands at around 219%. Like the S&P 500 Shiller CAPE Ratio, it also peaked in late 2021, reaching around 193% before the 2022 bear market began.