The CAPE ratio reaches highest level since 2000 — signals lower stock market returns

Based on the cyclically adjusted price-to-earnings (CAPE) ratio — investors should expect lower stock market returns in the coming years.

ELI5: You may be more familiar with the standard price-to-earnings (P/E) multiple — which helps compare if a stock is under or overpriced.

• Adding the “cyclically adjusted” removes the impact of recessions or expansions — making it comparable over different time periods.
• Generally — the higher the multiple, the more expensive a stock is.

That’s a handful but here’s what it all means.

The CAPE ratio reached 38.4x — the highest since the dot-com bubble in 2000 — when the S&P 500 lost nearly half its value in the following years.

• According to David Rosenberg (via FP), in the past 100 years, the S&P 500 has been this expensive 2% of the time.
• The CAPE ratio isn’t a good indicator of timing the market but it is useful to gauge future returns.

According to historical data, when the CAPE ratio is above 30x, the stock market returned an average of:

• 0.4% annually in the following 3 years.
• 2.1% annually in the following 5 years.
• 0.6% annually in the following 10 years.

Meaning: Investors should expect lower stock market returns in the next couple of years.

• In the past 5 years, the S&P 500 returned 14.9% — much higher than the 10.77% average over the past 100 years.
• The US has the highest CAPE ratio of some of the largest countries — China (15.7x), Europe (23.6x), Canada (25x).

What can you do with this info? Aside from lowering expectations, it might be time to explore other popular assets for portfolio diversification.

Rosenberg also recommends diversifying beyond US stocks into countries where valuations are cheaper.