Shiller CAPE Ratio

Robert Shiller of Yale University, alongside his collaborator John Campbell, developed the CAPE Ratio and published influential research in the 1980s and 1990s demonstrating that long-term stock market valuation measured by cyclically adjusted earnings had historically shown meaningful ability to explain subsequent decade-long equity market returns — a relationship that conventional one-year P/E ratios failed to capture reliably.

The construction of the CAPE Ratio addresses a fundamental problem with standard price-to-earnings analysis: earnings are highly volatile, rising sharply in economic expansions and collapsing in recessions. A P/E ratio calculated at the trough of a recession, when earnings are depressed, can appear misleadingly high, while a P/E calculated at the peak of an earnings cycle can appear deceptively low. By using the 10-year average of real (inflation-adjusted) earnings as the denominator, the CAPE smooths through multiple business cycles, providing a more stable and arguably more meaningful measure of how much investors are paying per unit of long-run normalized earnings power.

Historically, the U.S. CAPE Ratio has shown wide variation. Its long-run average from the late 19th century through the modern era has been approximately 16-17x. The ratio peaked above 44x at the height of the dot-com bubble in late 1999 — the highest level in its recorded history — before a subsequent decade of below-average equity market returns. It fell to approximately 13-14x at the 2009 financial crisis lows before embarking on a long expansion. By the mid-2010s and through the 2020s, the CAPE remained substantially above its long-run historical average for an extended period, reflecting both genuine structural factors and the effect of the ultralow interest rate environment.

The CAPE Ratio has generated significant academic and practitioner debate. Critics raise several objections. First, accounting standards for earnings have changed over time: the adoption of FASB mark-to-market rules and changes in how write-offs and non-recurring items are treated mean that recent GAAP earnings are not directly comparable to earnings from decades past, potentially making the ratio appear more elevated today than an apples-to-apples comparison would warrant. Second, the long-run average of the CAPE may itself have shifted permanently upward due to structural factors: lower transaction costs, broader global participation in U.S. equity markets, improved macroeconomic stabilization policies, and the growth of intangible-asset-intensive businesses that generate higher returns on capital than the industrial economy of the mid-20th century.

A third important critique is that the CAPE, while historically correlated with 10-year forward returns, has not been a reliable short-to-medium-term market timing tool. Markets can remain at elevated CAPE levels for extended periods while continuing to appreciate. An investor who exited U.S. equities when the CAPE first exceeded its historical average in the mid-1990s would have missed the most powerful phase of the dot-com bull market before the eventual correction.

Shiller himself has been careful to note that the CAPE is most useful as a long-horizon return forecasting tool rather than a near-term timing indicator. Used alongside other valuation metrics — including the Buffett Indicator, Tobin's Q, and the Equity Risk Premium — the CAPE provides one component of a comprehensive long-run valuation framework for understanding the historical context of U.S. equity market pricing.