The Cyclically Adjusted Price-to-Earnings (CAPE) ratio, also known as the Shiller P/E, is a valuation measure often used to assess the current value of the equity market and prospects for mid-to-long term future returns. It is calculated by dividing the index level or price by the average of ten years of earnings, adjusted for inflation.
Higher-than-average CAPE ratios are said by practitioners to imply lower than average future returns.
Equitable Investors assessed the effectiveness of this ratio using the data provided by Professor Schiller and Yale. Specifically, we have focused on the total return data for the S&P 500.
We reviewed CAPE ratios against subsequent five year returns and concluded that:
Future five year returns were higher, on average, for the lowest 20% of CAPE Ratios and lower for the top 10%;
The top 10% of CAPE ratios were followed by a five year period of negative returns with far greater regularity than any other decile;
But in between the bottom 20% of and top 10% of CAPE ratios, the trend between price and returns was very loose.
Analysis of daily CAPE data
Plot of CAPE ratios v subsequent 5 year total returns