CAPE Valuation and Long-Horizon Equity Returns in the US and China
Summary
The document explains the cyclically adjusted price-to-earnings ratio (CAPE), calculated as an inflation-adjusted share price divided by the average inflation-adjusted earnings per share over the prior decade. It compares CAPE with future real returns for the S&P 500, the Shanghai Composite, and other major markets. The reported historical analysis finds that higher starting CAPE tended to accompany lower future returns, with the relationship strengthening for longer forecast horizons in China.
It also describes a global allocation rule: rank more than 30 markets by CAPE, select the lowest-valued third when CAPE is below 15, and rebalance annually. The document reports historical returns and drawdown for this strategy, but those results do not establish future performance. It presents a dated assessment of China’s CAPE as unusually low and discusses why valuation benchmarks may shift over time, including changes in earnings composition, interest rates, and demographics. The analysis is limited by reliance on historical relationships and a mean-reversion assumption; it explicitly cautions that past patterns may not persist.
Key ideas
- CAPE divides an inflation-adjusted share price by the prior decade’s average inflation-adjusted earnings per share.
- The document reports an inverse historical relationship between CAPE and subsequent real equity returns in the US and China.
- Its cross-market example selects low-CAPE markets and rebalances the portfolio annually.
- Valuation comparisons depend on whether the market’s long-run valuation center remains stable.
- Historical associations and the mean-reversion assumption do not guarantee future returns.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.