CAPE Crusaders: The Shiller-Siegel Shootout at the Q Group Corral

By now, almost every investor has heard of the Nobel Prize-winning Yale professor Robert Shiller’s stock market valuation metric, the cyclically adjusted price earnings (CAPE) ratio.1 This measure is designed as an improvement on the traditional price-to-earnings, or P/E, ratio. To correct for earnings cyclicality, the CAPE uses an average of the last 10 years’ real, or inflation-adjusted, earnings in the denominator instead of just one year’s (trailing or forecast) earnings.

The CAPE ratio has been discussed in Advisor Perspectives by Doug Short, William Hester and the famed Wharton professor Jeremy Siegel. In other words, it’s quite a hot topic.

Siegel and Shiller made competing presentations at the Q Group’s fall 2013 meeting in Scottsdale, Arizona, on Oct. 15. (The Q Group is a discussion group of senior investment professionals, chiefly “quants,” that organizes prestigious conferences where academics and practitioners interact.) I wish I could say they faced off – they were scheduled to – but Shiller had been informed the previous morning that he had won the Nobel Prize, so he used a video connection to attend remotely. This article will report on their differing views and attempt to draw some conclusions about the market’s prospects.2

CAPE basics

Figure 1 shows the evolution of the CAPE ratio from 1881 to 2014. By historical standards, the CAPE ratio today is quite high, around 25. That is, the S&P 500 is priced at 25 times the 10-year average of real, trailing, reported earnings. This ratio is about 50% above its historical average and is considered by many analysts, including Shiller himself, to be indicative of low expected returns from this point forward.

Figure 1

Cyclically Adjusted Price Earnings (CAPE) ratio, January 1881-February 2014

Cyclically Adjusted Price Earnings (CAPE) ratio

Current CAPE Ratio: 24.99 (as of close on Feb. 10, 2014)







(Dec 1920)



(Dec 1999)

Source:, based on data from Robert Shiller’s web page.

Others are not so sure. Siegel, who supports the use of the CAPE ratio methodology in principle, believes that the current CAPE ratio of 25 cannot be directly compared with past or average values of the ratio for several reasons. First, the past 10 years still include the earnings collapse associated with global financial crisis, when S&P 500 quarterly earnings went negative. Second, real earnings growth accelerated after 1945, so it’s misleading to compare today’s valuation ratios with averages that go all the way back to 1871 or 1881. Third, accounting standards have changed and result in misleading data. Fourth, large losses suffered by specific companies are aggregated improperly into cap-weighted indices such as the S&P.

In a recent presentation at’s Inside ETFs conference in Hollywood, Florida, on Jan. 28, Siegel calculated a traditional (one-year) P/E of 17.2 for the S&P 500, compared with a median value, from 1954 to 2014, of 16.5. These ratios are price-to-forward (forecast) earnings. “There is no bubble here,” Siegel said.

Clearly, the traditional P/E tells a more bullish tale than the CAPE. (I am really struggling to avoid jokes about bulls, bullfighters, capes and tails.)

What’s right with CAPE

At the Q Group, Siegel began by saying that CAPE has been a good forecaster of stock returns. It also has a sound theoretical basis. “The CAPE methodology is brilliant and works; the data are the problem,” he wrote in the paper he distributed at the Q Group. Variation in CAPE has explained about one-third of the variation in actual subsequent 10-year stock returns, a very good track record.

The CAPE level of 43 in the spring of 2000 was a sign that a long period of bad times would follow. It did. Today, the CAPE method forecasts a 4.16% real return on stocks in the next 10 years, about two percentage points below the historical real return. This does not sound like a bearish forecast to me, but if one is counting on future returns being equal to long-run historical returns, it will be a little disappointing.3

Enigmatically, the equity-to-market-capitalization ratio is an even better forecaster. I’ll return to that later. In fact, price divided by any scaling variable — that is, any variable that makes it possible to compare price levels over time — appears to have some forecast value.

1. Also called the Shiller P/E or PE10.

2. Shiller did not respond directly to Siegel but made a related presentation on current vs. historical valuation of equity-market sectors and industries. One must admit that Shiller’s Nobel excuse for not showing up – or directly rebutting Siegel – was unique.

3. My own 10-year forecast, in Grinold, Kroner, and Siegel [2011], was for stocks to provide a nominal total return of 7%. Because inflation at the time was 2.4%, my implied real total return forecast was 4.6%, which is not very different from the CAPE forecast. I’d also note that my article foreshadowed Siegel’s (or else we unwittingly compared notes). I wrote,

The current Shiller P/E, by averaging 10 years of trailing earnings, includes an earnings collapse in 2008-2009 that is almost literally unprecedented; even the Great Depression did not see as sharp a contraction in S&P earnings, although overall [NIPA] corporate profits in 1932 were negative. (Huge losses in a few large companies, such as occurred in 2008-2009, go a long way toward erasing the profits of the other companies when summed across an index.) Only the depression of 1920-1921 is comparable.