Escape from CAPE Fear(s)

For many months, commentators we follow have warned a potential AI bubble and lofty stock valuations threaten markets’ rise this year.^[i] Now another alleged sign is garnering attention in publications we follow: America’s venerable S&P 500 Index’s cyclically adjusted price-to-earnings (CAPE) ratio is approaching all-time highs set at the apex of the early 2000s’ dot-com bubble, which commentators we follow posit heralds a market crash as the aforementioned bubble implodes. Our counsel? Slow down. Whilst we do see some budding euphoria toward US stocks and think vigilance is important, our research shows valuations aren’t helpful in assessing where markets go—and we find CAPE is even less helpful than most. In our view, CAPE is a bizarrely constructed, hugely flawed valuation measure with zero predictive powers.

For context, CAPE (also known as the Shiller P/E, after co-creator Robert Shiller) is a market valuation metric that divides the S&P 500’s current price by the prior decade’s average, inflation-adjusted earnings.^[ii] Its original purpose was to project 10-year forward returns, but many observers we follow have morphed this—using it to try to time turning points in US equity markets.^[iii] Our research finds it doesn’t work, as we will show, but this thinking continues showing up in publications we follow.

Most talk we have seen recently surrounds the S&P 500’s CAPE surpassing 40.0 in May before rising to 42.06 today.^[iv] Commentators we follow warn this is approaching the measure’s 44.19 all-time high in December 1999, roughly three months before the dot-com bubble burst and a bear market began in the S&P 500 when measured in US dollars.^[v] Given today’s widespread positive speculation around AI, some suggest this means US stocks are too expensive, opening the door to a prolonged market downturn as investors’ expectations become impossible for corporate results to match.^[vi]

Look, we agree there are likely some pockets of hot sentiment worth monitoring. But in our view, using CAPE as a timing tool is a faulty approach built on a broken indicator. Consider CAPE’s adjusting past earnings (the denominator) for inflation but leaving today’s price (its numerator) unadjusted. This suppresses the denominator—especially following periods of hot inflation—which we think artificially lifts CAPE and makes stocks appear more expensive. It is a bizarre thing to do, in our view, considering both sides of the earnings equation—costs and revenues—are subject to inflation, making nominal profits a sign of whether companies are overcoming price pressures. We think inflation-adjusting them in any context misses the point, especially when we think there are other, more useful means of scaling a company’s profitability.

CAPE also uses a decade of past earnings (versus the trailing 12 months of earnings used in a more traditional P/E), aiming to avoid skew from economic booms or recessions (periods of contracting economic output). Whilst that is perhaps a laudable aim, we think the solution makes the gauge very backward looking, allowing events from years ago to influence today’s CAPE. We think this, in and of itself, adds skew. Consider: Long after the fact, the deep 2008 recession depressed 10-year trailing corporate earnings, exaggerating CAPE.^[vii] Similarly, today’s CAPE includes 2020’s COVID lockdown-driven downturn (long since over and done with) and the US corporate earnings slump that followed hot inflation in late 2022 and early 2023.^[viii] All that is in the past, way in the past in some cases. Conversely, our research shows stocks look forward, pricing in the likeliest factors to influence earnings 3 – 30 months ahead. In our view, earnings from 10 years ago don’t affect today’s.

And whilst we find other, more standard P/Es can hint at sentiment when they spike or plummet rapidly, we think CAPE’s extra-backward-looking nature renders it fruitless in that regard. Many analysts and economists we follow suggest P/Es signal how much investors are willing to pay for earnings, but we highly doubt investors are incorporating earnings from 2016 when deciding to buy or sell. We think it is fair to presume these data are probably long out of their minds. Moreover, we find it odd to cite CAPE as a downturn warning signal considering these calculation quirks are an intentional effort to smooth over cycles. Again, it was never meant to be a tool that forecast peaks and troughs.

Perhaps that is why CAPE has been a poor market cycle predictor. Exhibit 1 helps shows this, charting the S&P’s CAPE at the beginning of each bear market—and each bear market’s cumulative decline—in US dollars since 1925, when good data begin. For context, CAPE’s median since 1925 is 17.82.^[ix]

Exhibit 1: Fluttering CAPE

Source: FactSet and Multpl.com, as of 18/8/2026. S&P 500 price return and CAPE in USD, 31/12/1924 – 17/8/2026. Currency fluctuations between the pound and dollar may result in higher or lower investment returns.

As the chart shows, no CAPE level clearly or consistently signals a new bear market start or predicts a decline’s magnitude. Bear markets started with below-median CAPE in 1946, 1980, 1987 and 1990. And whilst the rest began above this mark, CAPE varies widely in these years—ranging from 18.67 – 43.53. To us, this shows there is no magical level that predicts bear markets. As for magnitude, the three highest recorded CAPEs here—March 2000’s 43.53, January 2022’s 36.94, and September 1929’s 32.56—preceded widely varying declines.^[x] March 1937’s much milder 22.04, meanwhile, saw stocks drop a whopping -60.0% over the next five years.^[xi] We see no real connection there.

We witnessed lots of warnings about CAPE in the 2010s, which we think provides further colour. CAPE floated around its 1929 peak throughout much of the decade, eventually exceeding it in early 2018.^[xii] This was a frequent discussion topic amongst commentators we follow, though it was an excellent decade for US stocks.^[xiii] Whilst US stocks fell in 2018, we think valuations were coincident to this.^[xiv] Based on our research, the majority of that year’s slump started in late September and reached its apex in December, when numerous hedge funds were forced to fire-sell assets to meet redemption requests and planned closures. CAPE had nothing to do with forced selling, which resulted from years of poor fund performance.^[xv]

Ditto 2020’s bear market, which we find was exclusively about COVID lockdowns and not hot sentiment or stocks being too expensive.^[xvi] Whilst our research suggest investor sentiment was hot heading into 2022’s shallower downturn, with pockets of euphoria in Special Purpose Acquisition Companies (SPACs) and other niche corners, these aren’t represented in the S&P 500’s CAPE.^[xvii] In our view, there are other, better sentiment gauges that catch true euphoria.

Moreover, we think reacting to CAPE at the wrong time can have consequences. Rewind to 5 December 1996, when then-US Federal Reserve (Fed) chair Alan Greenspan famously questioned if investors’ “irrational exuberance” had “unduly escalated asset values.”^[xviii] Just two days prior, Shiller briefed Greenspan on CAPE’s rise, so we think it stands to reason the Fed chair had it in mind.^[xix] Yet that bull market continued for more than three years, with US stocks more than doubling.^[xx] Investors who sold on Greenspan’s warning would have missed out on huge gains, potentially straying them from their goals and objectives.

This bull market will eventually end, as all do. And yes, we do think currently elevated sentiment shows we are likely in this bull market’s latter stages. Yet our research finds those latter stages can last quite some time—and, in our view, CAPE won’t help investors navigate that.