This chart says the stock market is ready to crash

Usually when numbers shoot higher on Wall Street, it is a reason for celebration.That is not how Jonas Goltermann, the chief markets economist at Capital Economics, feels when he looks at one of the most feared charts on the stock market: the Shiller price-to-earnings (PE) ratio.“That’s obviously a bit worrying,” he says after seeing the metric on track to end the month at its highest level since August 2000.The Shiller PE ratio, a closely watched fear gauge on Wall Street, may sound esoteric, but it has become one of the most important numbers in the world – and one you should care about.For all intents and purposes, it is the canary in the coal mine for global financial crashes. And right now it’s blinking red.“It tells you that it probably is a bubble, but you don’t know when it’s going to end,” says Goltermann.The last time it was this high – August 2000 – was in the throes of the dotcom bubble collapse, when it was hitting record highs when applied to the S&P 500 – the benchmark stock index on Wall Street.The closely watched metric, used by traders to measure whether stocks are fairly valued, finished above 40 points for nearly two years between 1999 and 2000 – despite never previously hitting the mark in the 119-year history of the S&P index.When the dotcom bubble collapsed, the Shiller PE ratio was highlighted as evidence that the market should have seen a crash coming – but did nothing about it.Worryingly, the index has gone above the 40-point mark for the first time since the dotcom bust. It reached this level in May, June, July and August of this year as markets are gripped by the mania surrounding AI.“We’re probably closer to the end than the beginning – the final innings,” says Goltermann.“The moment we’re in right now, it feels like it is more driven by narrative and momentum. The price goes up because the price is going up.”The Shiller price-to-earnings (PE) ratio, developed by Robert Shiller, the Nobel Prize-winning American economist, is designed to measure whether stocks are “overvalued” – which is to say whether share prices are supported by the underlying earnings of a company.When it goes high, it suggests prices have become disconnected from the reality of company earnings – with froth and euphoria leading the charge.Had it been invented in the 1920s, it might have helped warn against the Wall Street crash, which triggered the Great Depression during the following decade.In 1929, the Shiller PE ratio would have surpassed a then-unprecedented 30 twice, a figure it did not reach again until 1997.“Now, it’s as high as in the late 1990s and late 1920s,” says Goltermann. “Those were both proper crashes… absolutely disastrous.“It’s very extreme to say we’re definitely heading for something like that. I don’t think that’s necessarily the case, but you would expect that at some point this AI narrative or AI bubble will go into reverse and you’ll see a substantial fall in the US stock market.”Goltermann thinks the stock market will fall by 20pc or more in the next 12 to 18 months and it is hard to find a fund manager who would argue with the Shiller PE.Today, the S&P 500 has only been more expensive to buy stocks a tiny fraction of the time (1.2pc) since 1881, according to the Shiller ratio.However, not all investors are expecting such a dramatic downturn in stocks, known as equities in the financial world.“Maybe there will be a correction, but it’s just a correction. It’s not a big global sell-off,” says Chris Morrison, a fund manager at Jupiter, the FTSE 250 asset manager, which handles £74bn.He admits the Shiller PE ratio makes him “cautious” that US tech stocks look expensive, but he is looking for a pause in the market’s rapid gains.“If you’re arguing that actually it’s going to be a sell-off, that’s so interlinked with borrowing, funding sources, that will have a knock-on effect on US yields. That’s a different, more extreme situation and we’re not positioned like that, to be honest.“I can certainly see just pausing for breath. In any instance in history, there’s certainly areas which get over-excited and you might have a correction.”It takes a fund manager’s head to remain calm in the face of indicators like the Shiller PE ratio.AdvertisementBut it is not the only thing echoing the dotcom exuberance of 26 years ago.Like in 2000, there is hype surrounding a new and as-yet not fully understood technology: Back then, it was the internet and now it is AI.Also mirroring the dotcom era, there is significant excitement around the stock market listings of tech companies.Pets.com, a website launched in November 1998, infamously raised nearly $83m (£61m) in a float in February 2000 after an advert was shown during that year’s Super Bowl.Its valuation eventually reached nearly $300m, but it was shut down in November 2000 after failing to become profitable.Investors might show caution after observing the hype around Elon Musk’s SpaceX.The rocket company’s valuation surged past $2tn days after its listing on the Nasdaq in June.It then plunged 53pc in a little over a month to fall below its offer price.Its float happened a month after the Shiller PE ratio crossed the 40 mark for the first time since the dotcom crash.Lauma Kalns-Timans, an analyst at Berenberg, was unequivocal. “US equities remain in bubble territory,” she said.Even bond markets – now established as the harbingers of doom for high-spending governments – are also flashing warning signs for stock market investors.Mike Riddell, a bond portfolio manager at Fidelity, says: “If you look at any kind of yield measure for equities, it’s now well below the yields you get on bonds.”Mr Riddell says he has become “nervous” about the credit market, where investors trade the debt of corporations.Tech giants such as Meta, Google, Amazon and Microsoft have driven a substantial surge in US corporate debt levels in recent years to fund their AI infrastructure plans.But Riddell is not reaching for the panic button. “What you’re going to need to have a really big correction in risky assets is actually a shock or evidence of a downturn in the global economy,” he says.“We’re not seeing evidence of a pronounced global growth slowdown, so I’m not saying that’s a view I have imminently. But I think just in terms of valuations, we are concerned.”That concern appears to be well placed. US stocks have spent less than one year out of the last 145 years trading at valuations above current levels.“When valuations are unattractive over the long term, you’ve tended to have inferior outcomes, say compared to when the valuations and the fundamentals line up,” says Robert Tipp, chief investment strategist at PGIM Credit.However, there is an argument that things could be different now compared to when the Shiller PE ratio was last closing in on a record high.“It’s not a timing tool,” adds Tipp. “You always have to look at the specifics of the situation. And the specifics of the situation are that investors for a handful of years running have underestimated the potential of major corporations to throw up sustained, very positive earnings growth. And if anything, we’re seeing that accelerate.”Golterman agrees. “I guess part of the reason that the stock market has gone so far now is that firms are making an awful lot of money.“What we saw in the 1990s was much more built on expectations about profits in the future and the frothiness, the pure froth, if you will.“Whereas today many of them are making money hand over fist in the here and now. So in that sense it is different.”Tony Dalwood, chief executive of UK investor Gresham House is not so sure.“Beware of people saying ‘it’s different this time’,” he warns.For close observers of the Shiller PE ratio, similar alarm bells are starting to ring.Try full access to The Telegraph free today. Unlock their award-winning website and essential news app, plus useful tools and expert guides for your money, health and holidays.