S&P 500 CAPE Ratio at highest level since dot-com bubble, history offers comfort

The Shiller CAPE Ratio, a valuation metric for the 500 largest publicly traded U.S. stocks, has reached its highest level since the dot-com bubble as of September 19. This cyclically adjusted price-to-earnings ratio is designed to provide a consistent measure of S&P 500 valuations across different economic conditions. Historically, such high readings have preceded significant market downturns, including the 1929 stock market crash that led to the Great Depression and the dot-com bust.

Despite these historical warning signs, the article suggests that long-term investors in the S&P 500 have historically seen strong returns, averaging about 10% annually over the past 98 years, even through major bear markets. It posits that the metric may not hold the same predictive power as in the past, and that current market conditions might support higher valuations for S&P 500 companies.

For investors concerned about large-cap stock valuations or seeking diversification, small-cap stocks are presented as a potential alternative. The iShares Russell 2000 ETF, which holds 1,957 small-cap stocks, has delivered annualized returns of approximately 10.5% over the last decade and has outperformed the S&P 500 in the past year. Vanguard research also forecasts that U.S. small-cap stocks will outperform U.S. large-cap and growth stocks in the next 10 years.