Equity Markets Valuation Using CAPE

When it comes to global equity portfolio allocations, relative stock market valuations are one of the most critical factors that influence investors’ decision-making.

“Are stocks undervalued or overvalued?” is an old and ongoing debate among financial market participants. This question is of the utmost importance given its considerable investment implications.

One approach to addressing the issue of determining whether the stock market is relatively cheap or expensive, is to use the Cyclically Adjusted Price-Earnings ratio (CAPE), a measure developed by the Nobel Prize-winning economist Robert Shiller of Yale University and his former colleague Prof. John Campbell.

In this paper, we first discuss the pros and cons of using this indicator as a market timing tool, we analyze what current valuations say about expected stock returns, and then we provide CAPE measures for the US and European equity markets