inCAPEable
The CAPE ratio ended 2025 near a 25-year high, but that doesn’t mean it’s time to turn bearish on stocks
The cyclically adjusted price-to-earnings (CAPE) ratio1 is often referenced by market pundits making bearish calls on stocks. Some believe this market valuation is inversely related to future market returns, meaning when it’s high, expected returns are low. Given the CAPE ended 2025 at 39.9, the highest it’s been in a quarter century, many in the market forecasting business see dark clouds ahead for stocks.
Investor fixation on the CAPE ratio is often fueled by charts plotting real (inflation-adjusted) 10-year stock returns against the start-of-period CAPE ratios. When plotted using monthly data, a negative relation between the two seems evident. However, there are flaws with this interpretation.
The first issue is that the return observations cover 10 years but are plotted monthly. That means points in Exhibit 1 are not independent observations—back-to-back data points share 119 of 120 monthly returns. It’s very hard to identify a reliable relation between two variables when the one you’re predicting has so much overlap between observations.
EXHIBIT 1
CAPE Ratio at Each Month-End vs. Real US Stock Returns over the Next 10 Year
Compounding the overlap issue is that many of the previous extreme CAPE readings (i.e., those above 35) took place between 1999 and 2001. So, we’ve got essentially one data point that just so happens to precede the disappointing 2000–2009 period for US stocks. Not very helpful for informing what we should expect of markets when the CAPE gets so high.
One way around the overlap issue is to use CAPE data at intervals that match the subsequent return horizon. Exhibit 2 below plots CAPE ratios at the end of each decade versus subsequent 10-year real returns. Now, the relation between CAPE and future stock performance looks much weaker. The late ’90s cluster of high CAPEs, captured by the December 1999 observation, clearly stands as an outlier.
Another reason for skepticism over dire predictions: The CAPE has been high for years, hitting 35 back in January 2021. Many pundits were predicting market declines back then. We have to wait a while longer to see the 10-year real return from that point, but the first five years have not exactly been rough sledding. The US market is up almost 49% net of inflation since then.2
Nobody knows what the future holds for markets. We’ve written recently about how high valuations today might be different from those of the late ’90s. Regardless, it’s advisable to tune out bearish predictions based solely on the CAPE.
EXHIBIT 2
CAPE Ratio at the End of Each Decade vs. Real US Stock Returns over the Next 10 Years
Footnotes
1. The CAPE ratio is calculated by taking the average of earnings for the past 10 years, adjusted for inflation. Data for this ratio are available on economist Robert Shiller’s website: www.econ.yale.edu/~shiller/data.htm.
2. In USD. Real return from January 1, 2021, to November 30, 2025, calculated as the Fama/French Total US Market Research Index return in excess of the change in the US consumer price index.
Glossary
Expected return: An estimate of average anticipated returns informed by historical data.
Real return: A return in excess of inflation.
Index Descriptions
Fama/French Total US Market Research Index: July 1926–present: Fama/French Total US Market Research Factor + One-Month US Treasury Bills. Source: Ken French website.
Results shown during periods prior to each index’s inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.
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