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Rekenthaler Report

Maybe There’s Something to the Shiller CAPE Ratio, After All

New research rehabilitates an old measure.

The Hope
The Shiller CAPE ratio has long intrigued investment practitioners, and to some extent the academic community as well. Devised by Nobel Laureate Robert Shiller, the equation calculates the S&P 500’s “cyclically adjusted price/earnings ratio,” which is a fancy way of saying that the index’s price is divided by average corporate earnings over the past decade, rather than by the most recent results.

Because that process stabilizes the output by smoothing an economic cycle’s peaks and valleys, the CAPE ratio would seem well-suited to gauge the stock market’s valuation across different periods. If the current CAPE ratio is 20, as opposed to 12 two decades ago, today’s stocks may be overpriced. Perhaps the CAPE ratio can be used to predict future stock market performance.