This Telltale Bear Market Indicator Is Sounding a Warning, Once Again

From time to time, Wall Street provides the investment community with a not-so-subtle reminder that stocks can go lower.

Due to reaching an all-time high of catch between mid-November 2021 and the first week of January 2022, the ageless Dow Jones Industrial Average (^ DJI Legal interest rate 0.59%)is widely followed S&P 500 (^ GSPC System efficiency 0.48%)and related to growth Nasdaq Composite (^IXIC 0.01%) decreased by 22%, 28%, and 38% respectively. This means that all three major US indexes have at least a brief taste of a bear market in 2022.

A man looks anxiously at a rapidly rising stock chart displayed on a tablet.

Image source: Getty Images.

Regardless of how long you have invested, bear markets can prompt you to question your decision to stay the course. In particular, the 2022 bear market has many wondering where the bottom might be. Although no single indicator, metric, or statistic has ever accurately predicted the start or end of every bear market, one bear market indicator has an unusually strong track record among investors.

This bear market metric suggests more trouble lies ahead for Wall Street

Looking back to 1870, the S&P 500 Shiller price-to-earnings (P/E) ratio has predicted the arrival of five bear markets. The Shiller P/E, also known as the cycle-adjusted price-to-earnings ratio (CAPE ratio), considers inflation-adjusted earnings for the previous 10 years.

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While on the surface the Shiller P/E is just another valuation tool, it is actually predicted to be a bear market any time it crosses 30 and holds that level. It rose from the top 30 in 1929 before the Great Depression, to 44th during the dot-com bubble, in the third quarter of 2018 and just before the coronavirus hit. passed through the 30’s, and again (briefly) during the 40’s. First week of 2022. The short version is that every time the S&P Shiller P/E ratio crosses 30 during a market, the S&P 500 declines at least 20% (key word, “eventually”).

S & P 500 Shiller CAPE Ratio Chart

S&P 500 Shiller CAPE Ratio data by YCharts.

But the Shiller P/E ratio can be an equally useful predictor of where the bear market will bottom. Except for the financial crisis (2007-2009), the quarter century saw a number of double-digit percentage declines in the S&P 500 when the S&P 500 Shiller P/E hit 22 (give or take). one or two points in each direction). This is not so surprising since professional and everyday investors are often more critical of stock valuations during bear market downturns.

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I’m sorry to say, but this overwhelming bear market signal is, once again, a warning that the broader market has yet to bottom out — at least if history proves correct. The latest collapse following a lower-than-expected U.S. inflation rate briefly pushed the S&P Shiller back above 29. Although anything is possible, there has never been a bear market with a Shiller P/E as high as it is now. did not fall below the bottom.

Considering that a number of high-profile companies have begun to moderate their views, all signs point to a bleak path for equities to end 2022 and/or begin 2023.

A smiling businessman holding a financial journal.

Image source: Getty Images.

This “alert” is your opportunity to strike

Although the S&P Shiller P/E ratio has a proven track record of accuracy, it is not perfect. But there is one thing that has a perfect record: the S&P 500 itself.

As I mentioned before, time is the greatest ally of investors. Trying to predict where the market will be a year from now is nothing but a mistake. However, the longer you stretch, the greater your chances of success and building wealth.

According to data compiled by market analytics firm Crestmont Research, there hasn’t been a 20-year period since 1900 when the S&P 500 has failed to deliver a positive total return, including dividends. In other words, if you hypothetically bought and held an index tracking the S&P 500 for 20 years, you would have made money 103 out of 103 times (which represents every year from 1919 to 2021 for these rolling 20-year periods). Most of the time, investors made a boatload of money, with over 40% of the last 103 years resulting in an annual total return of at least 10.8%.

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If you’re worried about “getting in too soon,” consider this: There have been 39 separate double-digit percentage declines in the S&P 500 since the early 1950s. correction, and bear markets were eventually cleared by a bull market. Again, it doesn’t really matter if you buy, as long as you invest enough time(s) to play around and prove your thesis right.

I also have to say that this is not just about the S&P 500. Any breaks, corrections and market swings in the Dow Jones Industrial Average and Nasdaq Composite were ultimately offset by bullish markets.

In short, if Shiller’s P/E ratio sounds a warning, it’s often a great time for opportunistic long-term investors to jump.


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