Key Points
Stock markets do one thing very well over the long term: They go up. But over the short term, anything can happen. Few people can accurately predict the next few weeks, months, or years of stock market action. Keeping a long-term focus is key to generating consistent profits.
Still, many investors can afford to think in terms of decades. Retirees and those saving for a near-term purchase, for example, may require an extra margin of safety.
If you’re concerned about a sudden drop in the value of your portfolio, you may want to heed caution. One of the most popular stock market indicators is now sounding the alarm.
Investors should worry about this stock market warning signal
The S&P 500 (SNPINDEX: ^GSPC) is one of the most popular stock market indexes in the world. One ETF tracking this index — the State Street SPDR S&P 500 ETF Trust — has nearly $800 billion in assets under management.
One of the most popular stock market metrics for gauging how expensive the market has become is the price-to-earnings ratio for the entire S&P 500. At a glance, this figure tells you roughly how high or low U.S. stocks are being priced. We can then compare this figure across history to gauge a relative sense of the market’s valuation.
First, the bad news: The S&P 500 currently trades at 32 times earnings, its highest level since just before the 2020 pandemic-era crash. The only times the market traded above 30 times earnings before 2020 were just before the financial crisis and the dot-com bubble burst. In short, markets seem to be priced in dangerous territory.
But here’s the thing: If you maintain a long-term perspective, none of this matters. Even if you only put money to work at the peaks of every previous bubble, you still wouldn’t have generated an impressive return over the long run. That’s the power of a long-term holding period.
So yes, certain stock market metrics are screaming that danger lies ahead. And there may be. But long-term investors should remember that continually putting money to work is the most reliable path to riches, not timing short-term corrections.
One of my favorite investment techniques for maximizing long-term returns is dollar-cost averaging. In a nutshell, this involves putting a regular amount of money to work. For example, you could have $250 automatically invested each month in a broad stock market index fund. When prices are high, this set dollar amount will naturally purchase fewer shares. And when prices fall, the same dollar amount will buy a larger number of shares. In this way, you can confidently continue to invest money in all market cycles without needing to time short-term fluctuations.
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Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
