The stock market is coming off nothing short of an historic year. In no particular order, Wall Street and investors navigated their way through:
- The benchmark S&P 500 (SNPINDEX:^GSPC) losing over a third of its value in less than five weeks during the first quarter.
- A record-breaking snap-back rally from the March 23 bottom that allowed the S&P 500 to hit an all-time high in under five months.
- A brief, but steep, negative print on West Texas Intermediate crude oil futures in April; and
- Historic volatility that took the CBOE Volatility Index to its highest reading ever in March.
Amazingly, the year ended with the S&P 500 higher by 16%, which represents a near-doubling of its average annual return since 1980. Not too shabby considering that the coronavirus disease 2019 (COVID-19) pandemic wreaked havoc on the U.S. economy.
Historically speaking, when this happens, the stock market crashes
The question most investors are now asking themselves is if the market is overheating.
Think about this for a moment: Since the beginning of 1950, the S&P 500 has undergone 38 separate market corrections of at least 10%. That’s one sizable move lower in equities every 1.87 years, on average. We may not know exactly when a crash or correction will occur, how long it’ll last, or how steep the decline will be, but we know that one is always coming.
Even though we can’t predict when a stock market crash will occur, we can certainly look to history for some helpful guidance. One such telltale sign is currently suggesting that big trouble is on the horizon.
The Shiller price-to-earnings (P/E) ratio is a P/E ratio based on the average inflation-adjusted earnings from the previous 10 years. Over 150 years of history, the Shiller P/E ratio for the S&P 500 has a mean (average) of 16.8 and a median of 15.8. Right now, the Shiller S&P ratio for the S&P 500 is 34.5 — more than double its historic average.
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