The Shiller P/E Ratio: The Most Worrisome Signs of a Correction?

One of the most worrisome signs we’re overdue for a correction is the Shiller P/E at 30.13.

Developed by Yale University’s Robert Shiller, the ratio helps us determine how much of your portfolio should be invested in stocks, based on the relationship between the price you pay for a stock and the value you get in return.

The S&P forward P/E ratio compares current market prices to average earnings over the last 10 years adjusted for inflation. And what it has exposed is terrifying, especially over the course of 2017.  The last two times it was this high – or higher – markets crashed not longer after. 

In 1929, the ratio sat at 30. The Dow Jones would crash from an October 1929 high of 352.69 to 198.69. In 2000, the ratio sat at 44.19 at the start of 2000. Not long after, the Dow Jones would slip from 11,638 to 9,731. In August 2017, it was back to 30.13. 

At such highs, even its creator warned such a high “would definitely be a negative for equities. It would be pretty big. We are at a high valuation. The only time we've had a higher valuation than where we are now was around 1929 and around 2000.”

"We could see a major correction," he said. "This is not a forecast. It's a worry."

Yet, in late 2017, investors were still piling into the stock markets at breakneck speed.

No one seemed to be concerned about excessive signs of overvaluation or optimism, just as we saw in 1929.  Even the press was still encouraging investors to buy at market highs.  USA Today for example just reported, “It’s still not too late to get in.  The gains are firmly rooted in business fundamentals, not false hopes.”

Even major banks are forecasting higher highs for the S&P 500. Credit Suisse recently raised its growth estimates to 2,550 from 2,500 and introduced a mid-year 2018 target of 2,600. Goldman Sachs raised its target from 2,300 to 2,400.  The problem with that, of course, is that forecasts are rarely correct and serve very little purpose.

Granted, none of us have a crystal ball. We can’t tell you with great certainty exactly when the next crash will happen. But what we can tell you is, the next one could catch many of us off guard again. All as markets have become ridiculously overvalued, stretched well beyond fair valuation just as we’ve with the previous crashes in 1929, 1987, 2000 and 2008.