Understanding the CAPE Ratio: A Historical Perspective

When investors want to know whether the stock market is "expensive" or "cheap," they often turn to price-to-earnings ratios. But the standard P/E ratio can be misleading during economic booms or busts, when short-term earnings are temporarily inflated or depressed. The CAPE ratio was designed to solve this problem, and it has become one of the most widely cited valuation metrics in modern finance.

What Is the CAPE Ratio?

The Cyclically Adjusted Price-to-Earnings ratio (CAPE), also known as the Shiller P/E, was popularised by Nobel laureate economist Robert Shiller of Yale University. It divides the current price of the S&P 500 by the average of real (inflation-adjusted) earnings over the previous 10 years.

By averaging earnings over a full decade, the CAPE smooths out the business cycle. It doesn't matter whether the economy is in a boom year with record profits or a recession year with depressed earnings; the 10-year average captures a more representative picture of sustainable earning power.

The formula is straightforward:

CAPE = Real S&P 500 Price ÷ 10-Year Average of Real S&P 500 Earnings

A Century of Data

One of the CAPE's greatest strengths is the depth of historical data available. Shiller's dataset extends back to 1871, giving us over 150 years of monthly observations. This long history reveals clear patterns:

• Long-term average: The historical mean CAPE is approximately 17. This serves as a rough benchmark for "fair value."
• Major peaks: The CAPE reached 33 before the 1929 crash, 44 at the peak of the dot-com bubble in December 1999, and exceeded 38 in late 2021.
• Major troughs: Following severe bear markets, the CAPE has fallen below 10, most notably during the Great Depression (1932) and in the early 1980s.

The pattern is consistent: periods of extremely high CAPE readings have been followed by below-average returns over the subsequent 10 to 20 years. Periods of low CAPE readings have tended to precede above-average long-term returns.

What the CAPE Tells Us (and What It Doesn't)

The CAPE is primarily a long-term valuation indicator, not a short-term timing tool. Research has consistently shown that:

• High CAPE predicts lower future returns: When the CAPE is well above its historical average, subsequent 10-year returns for the S&P 500 have tended to be below average. The correlation between starting CAPE and future 10-year returns is one of the strongest relationships in financial economics.
• The CAPE does not predict crashes: A high CAPE can persist for years before any correction materialises. The CAPE exceeded 25 in 1996, yet the market continued to rise for nearly four more years before the dot-com crash.
• Structural changes matter: Some analysts argue that today's higher CAPE levels are partly justified by lower interest rates, changes in accounting standards, higher profit margins, and the shift toward asset-light technology companies. Others counter that these arguments are versions of "this time is different."

How Crash Gauge Uses the CAPE Ratio

On the US Crash Risk Dashboard, the CAPE ratio is one of the highest-weighted indicators. Here's how it's incorporated:

1. Crash Gauge pulls the latest CAPE value from Robert Shiller's publicly available Yale dataset (ie_data.xls).
2. The current CAPE is ranked against its full historical distribution to produce a percentile. A CAPE at the 90th percentile means the market is more expensive than 90% of all historical observations.
3. Because a higher CAPE signals greater overvaluation risk, the percentile translates directly into a risk score. This feeds into the weighted composite alongside the yield curve, credit spreads, and other indicators.

The CAPE is currently available only for the US dashboard, as free, reliable CAPE data for international markets is not available through public APIs. International dashboards use other valuation proxies where possible.

CAPE vs. Standard P/E: Why the Difference Matters

Consider the difference during the 2008–09 financial crisis. As corporate earnings collapsed, the standard trailing P/E ratio for the S&P 500 briefly spiked above 120 in 2009, making the market appear wildly "expensive" at a moment when it was actually near a generational buying opportunity. The CAPE, using 10-year averaged earnings, showed a much more reasonable reading around 13, correctly signalling that long-term valuations were attractive.

This is exactly the kind of distortion the CAPE was designed to avoid. By smoothing over the business cycle, it provides a more stable and meaningful assessment of whether prices are high or low relative to sustainable earnings.

Key Takeaways

• The CAPE ratio divides the S&P 500 price by 10-year average inflation-adjusted earnings, smoothing out business cycle distortions.
• The historical average CAPE is about 17; readings above 25–30 have historically been associated with below-average subsequent returns.
• The CAPE is a valuation indicator, not a timing indicator; it tells you about expected long-term returns, not when a crash will happen.
• Crash Gauge gives the CAPE one of the highest weights in the US crash probability model, ranking it against its full 150+ year history.
• Combined with other indicators like the yield curve, credit spreads, and the VIX, the CAPE helps identify periods when multiple risk factors are elevated simultaneously.

The CAPE ratio has endured as a valuation benchmark for over a century because its core logic is sound: compare prices to a long-term earnings average, and you get a clearer picture of whether markets are expensive or cheap. It's not a crystal ball, but when combined with the other 13 indicators on Crash Gauge, it adds a crucial valuation dimension to the overall risk picture.

For the full technical details of how the CAPE and other indicators are weighted, see our Methodology page.