The CAPE ratio (Cyclically Adjusted Price-to-Earnings ratio), also known as the Shiller P/E, is a valuation measure for equity markets. It is calculated as:
CAPE = Price / Average Inflation-Adjusted Earnings over the Past 10 Years
Unlike the standard P/E ratio, which looks at earnings from just the last 12 months, the CAPE smooths out short-term fluctuations in profits caused by the business cycle. This makes it more useful for long-term investors assessing whether a market is expensive or cheap relative to historical norms.
Currently, non-U.S. large cap stocks trade at a CAPE ratio of 19, compared to 34 for U.S. large caps. While some premium for U.S. stocks may be warranted given the U.S. index’s heavier tilt toward high-growth technology firms, sector composition alone doesn’t explain the full gap. Relative to their own historical norms, U.S. equities are priced near the 96th percentile—among the most expensive on record—whereas non-U.S. markets sit around the 40th percentile, below their long-term median.
This is important because long-term returns are strongly influenced by starting valuations. Asset manager Research Affiliates, for example, projects annualised ‘real’ (meaning inflation-adjusted) returns of 6.1% for developed ex-U.S. large caps—more than four times the 1.5% expected for U.S. large caps.
A prospective 6% real return from non-U.S. stocks remains compelling even in today’s higher interest rate environment, where inflation-protected bond yields hover around 2–3%. A 3–4% return above bonds is in line with historical norms and offers fair compensation for the greater volatility of equities. It is only U.S. equities that now appear misaligned—offering low expected returns despite elevated valuation risk.
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