CAPE as a Valuation Measure for Long-Term Equity Returns

Summary

This document introduces the cyclically adjusted price-to-earnings ratio, or CAPE, as a way to compare equity prices with a decade of inflation-adjusted earnings. It summarizes historical analyses of the S&P 500 and Shanghai Composite, reporting that higher CAPE readings were associated with lower subsequent real returns. The relationship is described as stronger over longer horizons for the Shanghai Composite.

The note also outlines a simple international allocation approach: rank more than 30 major markets by CAPE, buy the lowest-valued third when their readings are below 15, and rebalance annually. It reports historical performance figures for that rule, while acknowledging debate over whether valuation levels should be judged against a fixed historical average. Structural changes in earnings, interest rates, and demographics may shift valuation norms. The evidence is historical and does not prove that CAPE predicts future performance; the document flags systemic market risk, model specification risk, and the possibility that historical patterns will not continue.

Key ideas

• CAPE compares an inflation-adjusted stock price with average inflation-adjusted earnings over the preceding decade.
• The historical evidence summarized in the note links higher CAPE with lower subsequent real returns.
• A described global strategy selects low-CAPE markets and rebalances once per year.
• Changes in earnings, interest rates, and demographics can affect the valuation level used as a benchmark.
• Historical relationships and mean reversion may fail to hold in future markets.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.