The Shiller cyclically adjusted price-to-earnings ratio for U.S. stocks is closing in on the peak it hit during the dot-com bubble in 1999. That long-term valuation gauge, often called the CAPE ratio, now stands at a level that has historically preceded sharp market downturns.
What the CAPE Ratio Measures
The CAPE ratio, developed by Nobel laureate Robert Shiller, compares stock prices to average corporate earnings over the past ten years, adjusted for inflation. By smoothing out short-term profit swings, it aims to show whether stocks are cheap or expensive relative to their long-term earning power. A reading near 30 is considered high; the ratio topped out above 44 in late 1999 before the Nasdaq collapsed.
Current figures put the CAPE ratio in the high 30s, within striking distance of that record. The last time it was this elevated, the market was in the final stretch of a technology-fueled rally that ended with a three-year bear market.
Historical Context and Investor Concerns
The dot-com crash erased trillions of dollars in market value between 2000 and 2002. While no two market cycles are identical, the CAPE ratio's track record as a predictor of long-term returns has made it a closely watched metric among both institutional investors and academics. A high reading suggests that future annualized returns over the following decade are likely to be below average.
However, critics argue that the CAPE ratio has been less reliable in an era of low interest rates and persistent low inflation. Some contend that the earnings measure used in the calculation is distorted by write-offs and accounting changes. Still, the current level has drawn attention because it matches a period of extreme exuberance.
What the Data Shows
The ratio's approach to the 1999 peak does not guarantee a crash. In fact, the CAPE ratio can stay elevated for years before a correction sets in. During the late 1990s, it signaled overvaluation for several years before the downturn actually began. But for investors who use the metric as a rough guide to market risk, the current reading is a red flag worth noting.
Corporate earnings have grown in recent years, but stock prices have grown faster. The gap between price and earnings is what drives the CAPE ratio higher. Whether that gap is justified by factors like low bond yields or technological innovation is a matter of debate — one the data alone cannot settle.
For now, the CAPE ratio's drift toward the dot-com peak serves as a reminder that valuations matter over the long run. What happens next depends on earnings growth, interest rates, and investor sentiment — none of which are easy to predict.
