Learning from history, is the US stock market not looking good?

Learning from history, the current situation of the US stock market is not looking good, and the turning point is not far away?

In a report on November 18, Deutsche Bank analyzed the similarities between the current market environment and three historical peaks: the internet bubble of the late 1990s, the market peak before the global financial crisis in 2007, and the market boom of 2021.

Risk assets have performed well over the past 18 months, but valuations across multiple asset classes are already at high levels. The cyclically adjusted price-to-earnings ratio (CAPE) of the S&P 500 has only exceeded the current level twice in the past century.

This raises thoughts about the similarities between the current market environment and three periods of abnormally high valuations in history. In all three cases, due to the already high valuations, there was little room for further increases, followed by significant corrections.

Specifically:

1. The internet bubble of the late 1990s: During this period, the stock market continued to rise, with the S&P 500 tripling in five years. However, as valuations became excessively high, the market experienced three consecutive years of decline from 2000 to 2002, the only such occurrence since World War II.

Similarities between the current market and that time include: the S&P 500's annual growth rate is expected to exceed 20% for two consecutive years, the Federal Reserve was in a loose monetary policy stance then and now, and the market is primarily driven by a few tech stocks.

It is worth noting that the internet bubble also demonstrated that even with initially high valuations, relentless increases can continue for a while. After the CAPE ratio reached the current level in early 1998, the market still rose for two more years; a high-valuation market can persist for some time until catalysts such as economic slowdowns bring an end to the rise.

2. The eve of the global financial crisis in 2007: Before the first global financial crisis, the market performed well, with the S&P 500 surpassing its 2000 record in May 2007, and volatility was low.

The current market also shows similar characteristics, such as very tight credit spreads (the current credit spread of US high-yield bonds has reached its lowest level since 2007). Additionally, prolonged stability may lead to risk accumulation and complacency, potentially laying the groundwork for the next financial instability.

3. The market boom of 2021: Stimulated by COVID-19 measures, US risk assets rebounded strongly by the end of 2021; however, valuations across multiple asset classes had become increasingly high. By November 2021, signs of a market downturn began to emerge, with the Nasdaq and Bitcoin reaching peaks that month, at which point Federal Reserve Chairman Jerome Powell confirmed that high inflation was not temporary, leading to a more hawkish shift in Fed policy. As inflation remained high and economic growth deteriorated in 2022, the market experienced sustained sell-offs, with the S&P 500 index dropping over 25% from its peak in January 2022 to its low in OctoberIn addition, the 10-year Treasury yield rose by 236 basis points overall in 2022, marking the largest annual increase since 1788.

Overall, the Deutsche Bank report summarizes that:

Historically high-return examples are often accompanied by significant reversals. In both cases, after the CAPE ratio reached current high levels, there were notable adjustments. When market valuations are excessively high, the room for further increases may be limited, and a turning point may arrive swiftly. Investors need to pay attention to market valuation levels and remain vigilant about the risks of market adjustments brought about by potential economic slowdowns or other catalytic factors