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Billionaire investor Jeremy Grantham is warning that the stock market could collapse a whopping 60% from its current levels. If true, this would be the worst stock market crash since the Great Depression. For almost 50 years, Grantham has made a career and a vast fortune from successfully predicting stock market crashes. Now, in 2024, he is calling today’s stock market the biggest bubble he has ever seen. You’re going to want to stick to the end of this video because the most worrisome part of what Grantham is saying is that he might actually be right.
One of the most common ways to see if the stock market is potentially overvalued is to look at a metric known as the “Shiller PE ratio”. The formula for calculating the Shiller PE ratio is a simple fraction. On the top of the fraction, we have the price of the particular stock market index we are looking at. In this case, the S&P 500. The S&P 500 is a market cap weighted index of the 500 leading publicly traded companies in the US. It is frequently used as a proxy for the entire US stock market. On the bottom of the fraction is the average, inflation adjusted, annual earnings over the last 10 years for the S&P 500.
Using the average earnings over the last 10 years helps smooth out fluctuations in the company’s profits that occur over different periods of an economic cycle. What that means in simple terms is that for businesses, there are good years and bad years when it comes to profitability. When the economy is stronger in one particular year, companies are likely to make more profits. When the economy is bad companies, on average, are less profitable. Using the average earnings over a 10 year period helps get a more accurate idea of what companies profits look like in what would be a normal year. Additionally, it is also important to adjust for inflation as inflation can make a company’s profits look artificially high. The last few years in the United States has been an example of that. If inflation in a year is 9% and a company’s profits also rise 9% that same year, the company isn't actually any more profitable after factoring in the impact of inflation. Profits for the company only increased because the price of everything went up due to inflation.
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