Bubble Trouble: The Stock Market is Wearing an Expensive CAPE
Just over 25 years ago, Yale professor Robert Shiller argued that the U.S. stock market was a massive bubble–and it would crash. This prediction turned out to be prescient.
In making his case, Shiller pointed to a metric he developed—the Cyclically-Adjusted Price Earnings (CAPE) ratio, sometimes simply referred to as the Shiller P/E.
The CAPE ratio compares average inflation-adjusted earnings over a 10-year period to current stock prices. By taking 10 years of earnings data into account, the measure aims to account for variations in corporate profits due to business cycle fluctuations.
Today’s CAPE is Sending a Warning to Investors
Right now, the CAPE ratio is flashing red for the U.S. stock market. At 37.9 as of December 2024, the measure is over twice its long-term average of 17.6 going back to 1900. Readings over 22 suggest that equity valuations are stretched due to overly bullish sentiment.
Consider the following episodes:
In 1929, on the back of the Roaring 20s, the CAPE ratio for the S&P 500 Index touched 32.6. As The Great Crash unfolded, stocks cratered 28.5% by 1930.
During the Nifty Fifty bubble, the U.S. equity market’s CAPE peaked at 22.3 in 1968. By 1969, the S&P 500 Index had fallen 11.4%.
In 2007 as the Housing and Commodity bubbles inflated, the CAPE ratio for the S&P 500 Index peaked at 27.6. By 2008, the market had declined 38.5%.
Source: Data as at December 2024. Robert Shiller data from January 1900 to December 2024, TradingView and Picton Mahoney Asset Management Research.
Now for Some Good News
The bad news is that we believe the U.S. equities strongly appear to be in the midst of a dangerous bubble. The good news? A 40/30/30 portfolio can offer advisors a more balanced and resilient approach for their clients in these frothy times than the classic 60/40 mix.
This material has been published by Picton Mahoney Asset Management (“PMAM”) on March 3, 2025
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