The S&P 500's Shiller CAPE ratio has climbed above 41, its highest level since the peak of the dot-com bubble, after breaching 35 only twice before since 1871. Both prior episodes ended in sharp market declines, and tariffs, war-driven oil prices, and Treasury bond strategy are now adding fresh pressure. Strong corporate earnings growth, however, could blunt the ratio's usual warning power this time.
A valuation level seen only twice before
The S&P 500 Shiller CAPE ratio now stands at slightly above 41, the highest reading since the dot-com bubble peaked. The metric, built by economist Robert Shiller from a 10-year moving average of inflation-adjusted price-to-earnings ratios, has breached 35 only twice in the past 155 years.
One breach came in late 1999 and early 2000, when the internet boom pushed corporate earnings multiples to extremes. The dot-com bubble burst roughly four years later, and the S&P 500 took years to recover. The other came in 2021, when the ratio climbed above 38 by year-end; the Fed then raised interest rates to fight post-pandemic inflation, and the index sank into a bear market.
Tariffs and oil prices add to the pressure
President Trump has imposed steep tariffs during his second term, using alternative authorities after the Supreme Court struck down tariffs issued under the International Emergency Economic Powers Act. Several studies have found that U.S. businesses and consumers, not other countries, are paying most of the resulting higher costs, which is driving higher inflation, even if only temporarily.
The U.S. attack on Iran also pushed oil prices higher, raising energy costs for Americans. Worries about inflation have led CME Group's FedWatch tool to boost the odds of a Fed rate hike by year-end to 87%, and interest rate increases helped trigger the 2022 bear market.
Meanwhile, the Treasury Department's move to repurchase older long-dated bonds and issue new, shorter-term debt is adding to the uncertainty, causing long-term yield volatility at a time when the elevated CAPE ratio leaves little cushion.
Earnings growth complicates the picture
Trump's policies did not push the Shiller CAPE ratio to its second-highest level ever, and neither did the Biden administration's. Robust corporate earnings growth could also reduce the ratio's predictive power compared with prior periods when it topped 35. FactSet has even found that strong earnings growth is pushing the S&P 500's forward earnings multiple down rather than up.
A high CAPE ratio has preceded sharp downturns twice before, but that does not guarantee a repeat. Different underlying market dynamics could offset the pressure building from tariffs, oil prices, and bond market shifts.
Source: Fool
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