S&P 500 CAPE ratio hits 42.84, nearing dot-com record in 155-year history

The S&P 500's cyclically adjusted price-to-earnings ratio has climbed to levels seen only once before in 155 years — just before the dot-com bubble burst.

The S&P 500's CAPE ratio reached 42.84 this month, the second-highest reading in history and within 3% of the dot-com era peak of 44.19.

"The CAPE ratio is now at a level last seen before the dot-com bubble burst," said John Higgins, chief economic adviser at Capital Economics. "More than two-thirds of the S&P 500's gains since early 2023 can be attributed to rising valuations rather than improvements in underlying earnings."

The ratio has climbed more than 12 points since the start of 2023, pushing it well above the long-term average of 17.39 that has held since 1871. The CAPE ratio has sustained above 30 only three times in history: during the dot-com bubble, briefly in early 2022, and the current period. The brief January 2022 breach above 40 preceded a nine-month bear market that erased a quarter of the S&P 500's value.

At current levels, the S&P 500 is pricing in optimism that leaves little room for disappointment. Even a modest slowdown in profit growth or a shift in Federal Reserve policy could trigger a sharp repricing, with history suggesting flat or negative real returns over the following decade after similar valuation extremes.

The CAPE ratio, developed by economist Robert Shiller, divides the S&P 500's price by average inflation-adjusted earnings over the prior decade, smoothing out cyclical distortions. Its current reading places the index in territory that has historically preceded severe drawdowns. During the dot-com collapse, the Nasdaq Composite lost 78% of its value and the broader S&P 500 was nearly cut in half.

Valuation Expansion Driving the Rally

Capital Economics estimates that more than two-thirds of the S&P 500's gains since early 2023 stem from multiple expansion rather than earnings growth, a dynamic the firm described as a potential "blow-off phase" of the AI-fueled rally. The forward 12-month earnings multiple stands near 21, well below dot-com extremes, but the CAPE's 10-year smoothing mechanism captures a broader picture of elevated expectations.

The S&P 500 has spent the vast majority of its 155-year history trading at CAPE ratios between 17 and 18. Readings above 40 have occurred only during continuous bull markets on three occasions, including the present. Each prior instance ended with the index down 20% or more.

Cross-Asset Context

The elevated equity valuations coincide with a U.S. 10-year Treasury yield that has added pressure to growth stocks, while the DXY dollar index has remained firm, creating a challenging backdrop for multinational earnings. The CBOE Volatility Index has remained subdued relative to history, suggesting complacency among options traders even as valuation metrics flash warning signals.

History's Track Record

Bespoke Investment Group data shows the average S&P 500 bear market lasts 286 calendar days, while the average bull market runs 1,023 days — more than three times as long. Crestmont Research's analysis of rolling 20-year total returns since 1900 found that all 107 such periods produced positive annualized returns, a track record that reinforces the case for patient investors even after buying at expensive valuations.

Still, the magnitude of the current overvaluation is historically anomalous. The CAPE ratio has exceeded 40 only during the dot-com era and the present day, and the consequences of the former were severe enough to define a generation of investor caution.

This article is for informational purposes only and does not constitute investment advice.