The stock market has repeatedly rebounded through tariff disputes, a software selloff, and rising Treasury yields, reaching new record highs. The main concern shifts from external shocks to valuation. The cyclically adjusted price-to-earnings ratio, or CAPE, compares today’s price to inflation-adjusted average earnings over the prior 10 years, smoothing out temporary economic swings. Backtests using data from the 1870s show a long-term S&P average CAPE near 17. The current CAPE is 41.35, the second-highest in recorded history, only below the dot-com peak in November 1999. Elevated CAPE levels have historically been followed by weaker long-term returns, even though timing is not precise.
"Unlike a standard P/E ratio that compares stock prices to one year of earnings, the CAPE ratio uses inflation-adjusted average earnings over the prior 10 years. The idea is simple: smooth out temporary booms and recessions to get a clearer picture of whether stocks are expensive or cheap."
"Shiller backtested the metric using market data stretching back to the 1870s. The long-term average CAPE ratio for the S&P sits around 17. Today, the CAPE ratio stands at 41.35, the second-highest reading in recorded market history. Only November 1999's dot-com bubble peak was higher at 44.19."
"That December 2021 reading matters because the market peaked just days later on Jan. 3, 2022. Over the next six months, the S&P 500 fell 21% - the worst start to a year since 1970."
"Let's be clear: CAPE does not predict exact timing. Markets can remain expensive longer than investors expect. The late 1990s proved that. But historically, elevated CAPE readings have consistently pointed to weaker long-term returns and higher"
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