standards implemented in 1993 and 2001 resulted in significantly reduced earnings for companies listed in the S&P 500.
The “dramatic decline in reported earnings” resulting from
changes in the way GAAP data is reported causes return forecasts to be lower when these returns are used to calculate the
Siegel (2016) argues that “[a]ccurate evaluation of the CAPE
model requires that the earnings series used observe consistent
and uniform conventions across time.” He tests his hypothesis
by calculating the CAPE ratio using earnings calculated “by the
national income economists at the Bureau of Economic
Analysis” in place of the S&P series. The resulting forecast suggests “significantly higher stock returns.” Siegel does not take a
position with regard to “whether the recent changes in accounting conventions are ‘right’ or whether current earnings are too
high or too low relative to some ‘true’ value.”
James E. Mc Whinney is owner at J. Mc Whinney Communications.
Contact him at firstname.lastname@example.org.
1. Shiller (1996) forecast the S&P 500 Index would decline by 38.07 percent over the next ten years. Although the S&P 500 appreciated by 41
percent over that period and real annual stock returns averaged 5. 6
percent, the S&P 500 fell by more than 60 percent from October 2007
to March 2009, partially vindicating Shiller’s bearishness.
2. More exactly, each month over the past ten years is represented by
the twelve-month-lagged per share earnings, which are deflated by
the CPI (consumer price index) in each month and the 120 months of
lagged data are then averaged. Monthly data are obtained by inter-
polating quarterly data since 1926 and annual data before 1926. For
more information the data series, see Shiller (1990, 2000).
campbell, John y., and Robert J. Shiller. 1998. Valuation Ratios and the
Long-Run Stock Market Outlook. Journal of Portfolio Management 24,
no. 2 (winter): 11–26.
Greenspan, Alan. 1996. “The Challenge of Central Banking in a Democratic Society.” Speech delivered at the Annual Dinner and Francis
Boyer Lecture of the American Enterprise Institute for Public Policy
Research, Washington, DC ( 5 December).
Shiller, Robert. 1990. Market Volatility. Cambridge. MA: MIT Press.
–——. 1996. Price Earnings Ratios as Forecasters of Returns: The Stock
Market Outlook in 1996 (July 21). http://www.econ.yale.edu/~shiller/
–——. 2000. Irrational Exuberance. Princeton, NJ: Princeton University
Siegel, Jeremy J. 2016. The Shiller CAPE Ratio: A New Look. Financial
Analysts Journal 72, no. 3 (May/June): 41–50.
Researchers Robert Shiller and John Campbell devel- oped the “cyclically adjusted price–earnings ratio” (CAPE ratio) valuation measure to forecast stock
market returns (Campbell and Shiller 1998). CAPE first
gained attention on December 3, 1996, when Shiller and
Campbell “presented a preliminary version of their research
to the Board of Governors of the Federal Reserve.” The CAPE
ratio has also been credited as part of the body of research
behind “Fed Chairman Alan Greenspan’s (1996) ‘irrational
exuberance’ speech.” 1 Further, “[a]t the top of the bull market
in 2000, the CAPE ratio … correctly forecast the poor equity
returns over the next decade.” By January of 2015, the
CAPE ratio suggested “a 10-year future real stock return
of only 2.20%.” This “forecast of meager stock returns is
the result of two factors: the higher valuation of equities
and the forecast decline of the CAPE ratio.”
A variety of reasons have been cited for the elevated CAPE
ratio in the January 2015 forecast, including overly optimistic
investors selling their holdings and exerting downward pressure on stock prices when earnings growth fails to materialize,
“the dramatic fall in the real yield on bonds,” and “a lower risk
premium required by investors.” Researcher Jeremy J. Siegel
has another perspective. Siegel (2016) believes the forecast is
lower than it should be due to “changes in the way GAAP earnings are calculated, particularly with respect to mark-to-market
mandates.” He explains that “the use of S&P reported earnings
in CAPE calculations biases CAPE returns upward and forecasts of real stock returns downward,” because the CAPE ratio
is calculated “by dividing a long-term broad-based index of
stock market prices and earnings from 1871 by the average of
the last 10 years of earnings per share, with earnings and stock
prices measured in real terms. 2”
Siegel (2016) points out that “the nature of the earnings series
that is substituted into the CAPE model has not been consistently calculated,” due to changes in the generally accepted
accounting principles (GAAP) that underlie “the Standard &
Poor’s reported earnings series that Shiller used in computing
the CAPE ratio.” He notes that mark-to-market accounting
The Shiller CAPE Ratio: A New Look
Reviewed by James E. Mc Whinney