With the S&P 500 (SNPINDEX: ^GSPC) and Nasdaq Composite hitting all-time highs last week and the Dow Jones Industrial Average doing so the previous week, stock valuations have entered the danger zone. At only one other time in history has the Shiller P/E ratio been this high. This inflation-adjusted gauge, which looks at valuations over 10 years, stands today at 42.6.
The only other time it was higher was in November 1999, when it hit 44.2. What followed was a nearly two-year bear market. This Rare Signal Is Flashing Again.
In 2009, a "Double Down" signal flashed for a little-known chipmaker called Nvidia. For the first time in years, that same "Total Conviction" signal is flashing for a company 1/100th the size of Nvidia. Continue » The 12-month-trailing S&P 500 P/E ratio is also at its highest point since 2000 at 30, while the Nasdaq-100 is slightly above average at 29.7, but nowhere near the 78.2 it hit in 2002.
The Shiller P/E has been a pretty reliable gauge over the years, as the market has suffered either a correction or bear market after it spiked in 1929, 1965, 1999, and 2021. While it is impossible to predict the future, knowledge of history can prepare us for any eventuality. If a bear market or correction does follow this spike in the Shiller P/E ratio, here's the first thing I'm doing.
One of the most famous quotes by former Berkshire Hathaway CEO Warren Buffett is to be fearful when others are greedy and be greedy when others are fearful. That speaks quite directly to the market we're in right now. With stock valuations so high, it is important to be more selective than you normally might.
While there are still some great stocks at reasonable valuations out there, like Amazon and Alphabet, there are many more to be wary of, too. It may not, in fact, be the best time to pour more money into a broad S&P 500 exchange-traded fund (ETF), as you are buying near the top of the market. But it does make sense to favor actively managed ETFs or to seek out individual stocks that are reasonably valued and have earnings catalysts, such as Micron Technology (NASDAQ: MU).
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