Stocks sank in the first several weeks of the year, with the S&P 500 and the Nasdaq posting their worst quarters since 2022. But prior to that moment, these indexes delivered two straight years of explosive gains, led by growth stocks and artificial intelligence (AI) players. Investors were excited about signs of lower inflation and the possibility of interest rate cuts -- and they chose stocks that could thrive the most in a strong economic environment.
All of this led to a huge run-up in stock prices, with one particular valuation metric reaching a level it only hit twice before since the 1950s, when the S&P 500 launched in its current form. So, as a whole, the market became more and more expensive over the past couple of years, leaving certain stocks trading at record levels.
In recent weeks though, the mood in the market has shifted. President Donald Trump's initial talks of tariffs on imports -- and his formal announcement of them this week -- have weighed on investor sentiment. The concern is these tariffs will lift prices and therefore hurt both earnings and economic growth. All of this has weighed on stock performance, and it's pushed the S&P 500 Shiller CAPE ratio to make a decidedly clear move. Let's check out what history says may happen next.
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What's the Shiller CAPE ratio?
First, what exactly is the S&P 500 Shiller CAPE ratio? It's a valuation metric that considers stock price and earnings per share over a 10-year period -- to smooth out fluctuations across various economic environments. This makes it a pretty reliable and much-watched measure.
Late last year, the Shiller CAPE ratio peaked at a level of more than 37, something it's only done two times before -- in 2021 and in 2000. With the average level over time being about 17, stocks at this peak looked particularly expensive.
Now, let's consider this metric's recent move and what to expect next. The Shiller CAPE ratio has started to decline over the past several weeks and today it's reached the level of 35 -- this still is well above its average but shows that stocks are starting to become a better value for investors. A look at history now tells us something interesting: Following such movements in the past, the S&P 500 began a period of gains, and this suggests the index soon could do the same.
S&P 500 Shiller CAPE Ratio data by YCharts
Of course, history isn't always spot-on -- macroeconomic or industry news could impact the market's movements regardless of the overall valuation landscape. So, today, for example, pressure from Trump's new import tariff plan potentially could delay a rebound. But the good news is, even if this happens, it's likely to be a temporary situation. Throughout the stock market's history, it's never fallen for very long without recovering and then going on to gain.
A big opportunity for investors
Meanwhile, the S&P 500 Shiller CAPE ratio's movement offers investors a big opportunity. Many stocks have reached very interesting -- and in some cases dirt cheap -- valuations. Considering the stock market has always advanced over the long term, now is an excellent time for investors to start shopping around for stocks to buy and hold onto for the long haul.
This strategy allows you to get in on a quality player when it's undervalued and potentially benefit as the general economic environment improves and the stock advances. Some great examples can be found in the "Magnificent Seven," a group of tech giants that led gains over the past two years but have tumbled in recent weeks. For example, artificial intelligence (AI) chip leader Nvidia (NVDA +0.29%) today trades for only 23 times forward earnings estimates, down from 50 earlier this year.
NASDAQ: NVDA
Key Data Points
And e-commerce giant Amazon's valuation has dropped to 28 times forward earnings from 42 back in December. These two companies have proven themselves over time, so even if they face headwinds today, there's reason to be confident in their long-term prospects.
It may be hard to convince yourself to buy a stock when the market is in turmoil, but over time, this has been a successful strategy. Today, with valuations declining, history shows stock market gains may be just ahead -- and the great news is even if this phase takes longer than you'd like to arrive, it will come. That's why it's a fantastic idea to buy stocks when they're down and hold on for the long term.
