In January, the S&P 500 confirmed its presence in a bull market and is heading for a second year of double-digit gains, climbing 25% this year after a 24% increase in 2023. Growth stocks, especially those in the hot area of artificial intelligence (AI), have led the way. Investors have piled into companies in the field thanks to AI’s potential to transform our personal and professional lives — from helping us organize our households to helping companies become more efficient.
You’re probably familiar with many of these stock market stars that have made AI the priority — and that have soared in recent times as a result. Nvidia, (NVDA -3.26%) the No. 1 AI chip designer, and Palantir Technologies, a software company using AI, have surged about 200% and 250%, respectively, this year. Tech giants Amazon and Meta Platforms, which are also investing heavily in AI, are heading for double-digit gains.
This momentum has led one particular measure of stock valuations to do something it’s only done three times since the S&P 500’s debut as a 500-company index in the late 1950s. Let’s check out the details and consider what may happen next.
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The S&P 500 Shiller CAPE ratio
The measure I’m talking about is the S&P 500 Shiller CAPE ratio. Like a traditional price-to-earnings ratio, it offers us a view of the earnings of a company in relation to price — but there’s one key difference. The Shiller CAPE ratio is adjusted for inflation, considering the earnings of a company over a 10-year period. So some may say it offers us a more accurate picture of a stock’s value.
Today, this measure has reached beyond the level of 35 for only the third time since the late 1950s. The other two times this happened were as markets rallied following the coronavirus market crash, and in 2000, before the dot-com bubble burst.
S&P 500 Shiller CAPE Ratio data by YCharts.
This shows us that the market as a whole is looking expensive — in fact, it’s at one of its priciest levels ever since the launch of the S&P 500 as we know it today. History shows us that, following peaks in the Shiller CAPE ratio, the S&P 500 has declined, suggesting that such a movement could be next on the agenda for us these days.
That said, before worrying about the potential for declines, it’s important to consider a few things. First, it’s impossible to predict when an eventual decrease will occur. Other elements, such as excitement about ongoing growth in the AI market or optimism about the economy — for example, following the recent interest rate cut — could come into play and keep this upward momentum going. If you sell your stocks out of fear of potential declines, you could miss out on such a movement.
Some stocks thrive through tough environments
Second, a general stock market decline doesn’t mean every stock you own will fall. Some of your positions may hold up well or even thrive the next time the market dips. A difficult market phase won’t necessarily hurt all of your holdings, and your portfolio may perform better than you may have expected.
Along these lines, it’s also important to note that just because the market as a whole looks expensive doesn’t mean every stock is pricey. Even as the S&P 500 Shiller CAPE ratio has reached a high, certain stocks remain a good value. For example, tech giant Alphabet (GOOG -1.95%) (GOOGL -1.76%) currently trades for only 22x forward earnings estimates, which looks dirt cheap considering its earnings track record and future prospects.
Finally, when investing, it’s crucial to focus not on short time periods of gains or losses, but instead on the long term. Stocks will go through bull markets and bear markets — history shows us that. But if you buy quality companies at reasonable prices and stay invested over the long term, you don’t have to fear an impending market decline. Bull markets generally last much longer than bear markets, offering quality stocks plenty of time to win if you hold on to them for the long haul.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Adria Cimino has positions in Amazon. The Motley Fool has positions in and recommends Alphabet, Amazon, Meta Platforms, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.
