The Shiller P/E Explained: Reading Valuation Levels Correctly
The classic P/E compares price to a single year’s earnings — making it hostage to the profit cycle: markets look cheap in boom years and absurdly expensive in recessions. Robert Shiller solves this by relating price to the inflation-adjusted average of the past ten years of earnings. This CAPE (Cyclically Adjusted P/E) is probably the most cited valuation metric for entire equity markets.
The key question for you: what does a high Shiller P/E actually tell you — and what doesn’t it?
CAPE: methodology and historical predictive power
By smoothing over ten years, the CAPE filters out cyclical earnings swings. For the US market, the long-run historical average sits around 16 to 17; extremes were marked in 1929 (around 30) and the dot-com bubble in 2000 (around 44). Since the 1990s, however, the average has been notably higher — which complicates interpretation.
The core empirical finding: the higher the CAPE at entry, the lower real equity returns over the following 10 to 15 years tended to be on average. The relationship is statistically robust, but it is a tendency with wide dispersion — not a point-forecast tool. A CAPE of 35 does not say “crash”; it says expected returns from here are below the historical 7–8% p.a. nominal.
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The Buffett indicator as a complement
The Buffett indicator relates a country’s total market capitalisation to its GDP. Readings well above 100% were historically considered expensive; for the US it has been far above that for years. Both metrics measure similar things but have different weaknesses:
| Metric | Measures | Main weakness |
|---|---|---|
| Shiller P/E (CAPE) | Price vs. 10-year real earnings | Sector mix and accounting standards shift the “normal” level across decades |
| Buffett indicator | Market cap vs. GDP | Ignores foreign earnings — US corporations generate much of their profit abroad |
Limits: valuation is not a timing signal
Markets can stay “too expensive” for years: anyone who exited when the CAPE crossed its historical average would have missed much of the bull market since 2013. Interest rates matter too — low rates justify higher valuations in discounted cash flow terms, so comparisons across decades start from a skewed base.
Used sensibly, the Shiller P/E is an expectation-management tool: plan more conservatively at high valuations (savings rate, withdrawal rate, return assumptions) instead of timing an exit. If you let valuation inform your asset allocation, adjust weights gradually — and keep it clearly separate from sentiment gauges like the Fear & Greed Index, which measure short-term mood, not long-term valuation.
Frequently asked questions
What is a “normal” Shiller P/E?
Historically the US average was around 16 to 17, structurally higher since the 1990s. Readings above 30 were historically rare and, on average, accompanied by below-average subsequent returns.
Should I sell when the CAPE is high?
No. The CAPE has no timing power — markets often stay above their historical averages for years. It is useful for calibrating return expectations, not as an entry or exit signal.
Why do CAPE and the Buffett indicator sometimes disagree?
They use different reference bases: real average earnings vs. GDP. Foreign earnings, sector mix and interest rates affect each differently — which is why both belong in the picture only as rough orientation.
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