From time to time, Wall Street reminds the investing community that stocks can go down.
Since hitting their all-time closing highs between mid-November 2021 and the first week of January 2022, Ageless Dow Jones Industrial Average (^ DJI 0.59%)widely followed S&P500 (^GSPC 0.48%)and equity-driven growth Nasdaq Compound (^IXIC 0.01%) dropped by 22%, 28% and 38% respectively. This means that all three major US indices have had at least a brief taste of a bear market in 2022.
Image source: Getty Images.
No matter how long you’ve been investing, bear markets can make you doubt your resolve to stay the course. In particular, the 2022 bear market has many people wondering where the bottom might be. While no indicator, metric, or statistic has accurately predicted the start or end of every bear market, a telltale bear market indicator has an exceptionally strong track record of warning investors.
This Bear Market Gauge Indicates More Trouble Ahead for Wall Street
Going back to 1870, the S&P 500 Shiller Price/Earnings (P/E) ratio predicted the arrival of five bear markets. The Shiller P/E, also known as the cyclically-adjusted price-to-earnings ratio (CAPE ratio), takes into account inflation-adjusted earnings for the previous 10 years.
While on the surface the Shiller P/E is just another valuation tool, it is an accurate predictor of an upcoming bear market whenever it breaks above 30 and holds that level. This includes peaking above 30 in 1929 before the Great Depression, peaking at 44 during the dot. the first week of 2022. The short version is that whenever the S&P Shiller P/E ratio goes above 30 during a bull market, a decline in the S&P 500 of at least 20% eventually follows (keyword, “eventually”).
S&P 500 Shiller CAPE ratio data by YCharts.
But the Shiller P/E ratio can be just as useful in predicting where a bear market will bottom. With the exception of the financial crisis (2007-2009), a number of double-digit percentage retracements in the S&P 500 over the past quarter century bottomed out when the S&P 500 Shiller P/E hit 22 (plus or minus a point or two in each direction). This is not so surprising given that professional and ordinary investors often become more critical of stock market valuations during bear market declines.
I’m sorry to say, but this telltale bear market indicator is, once again, a warning that the broader market has yet to find its bottom – at least if the story turns out to be accurate. The latest rebound from weaker-than-expected US inflation took the S&P Shiller briefly above 29. While anything is possible, no bear market has ever bottomed with the Shiller P/E this high. than it currently is.
Given that a number of leading companies have begun to temper their outlook, all signs seem to point to a bumpy road for stocks through late 2022 and/or early 2023.
Image source: Getty Images.
This “warning” is your opportunity to pounce
Although the S&P Shiller P/E ratio has proven itself, it is not perfect. But there is something that has a perfect balance sheet: the S&P 500 itself.
As I have already pointed out, time is an investor’s best ally. Trying to predict where the market will be in a year’s time is nothing more than a roll of the dice. However, the longer you hold, the more likely you are to be correct and build wealth.
According to data compiled by market analyst firm Crestmont Research, there hasn’t been a continuous 20-year period since 1900 when the S&P 500 failed to deliver a positive total return, including dividends. paid. In other words, if you hypothetically bought and held an S&P 500 tracking index for 20 years, you made money 103 times out of 103 (each year from 1919 to 2021 representing the last years of these rolling periods of 20 years). Most of the time, investors have made a lot of money, with more than 40% of the last 103 years translating into an average annual total return of at least 10.8%.
If you’re worried about “entering too early,” consider this: There have been 39 separate double-digit percentage declines in the S&P 500 since the start of 1950. Excluding the current bear market, the previous 38 crashes, corrections, and the bear markets were eventually eliminated by a bull market. Again, no matter when you’re buying, as long as you give your investment enough time to materialize and prove your thesis correct.
I should also clarify that this is not unique to the S&P 500. Every crash, correction and bear market in the Dow Jones Industrial Average and Nasdaq Composite has also been eventually swept away by bull markets.
In short, if the Shiller P/E ratio sounds like a warning, it’s often the perfect time for opportunistic long-term investors to pounce.
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