This post looks at how the S&P 500 performs based on CAPE valuations over a 60+ year horizon. We find there are useful signals in extremes of CAPE valuations but acting on those instances is likely more beneficial when the CAPE is substantially undervalued vs. historical averages rather than when it is substantially overvalued.
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Most clients and prospects we’ve spoken with over the past few months have expressed frustration with their prior advisors not giving them a straight answer on whether the market is overvalued and what, if anything, should be done about it. We like to use data and analysis to inform our reasoning and guidance to clients so let’s take a look at what one of the popular valuation metrics says about the state of the markets today.
The Market is Overvalued According to the CAPE Ratio
The CAPE ratio is one of the datapoints we look at when assessing the state of the market’s valuation and long-term prospects (we are strong believers that investment decisions cannot be made with any singular datapoint). The CAPE divides the current market price of stocks by the average of their inflation-adjusted earnings over the past 10 years. It is essentially a PE ratio that looks beyond just one year of earnings in order to smooth out the bumps in the business cycle.
October 2025’s CAPE ratio was 39.51 according to Schiller’s latest dataset. This is the 98.7th percentile of all available monthly readings. The only other time the CAPE was higher than this was during the lead-up to the Dotcom crash. So, yes, we think the market is richly valued right now vs. historical levels.
The CAPE Ratio Can Help Inform Allocation Decisions
While we agree with most investment research that says it’s impossible to predict short-term stock price movements, we feel one can at least make data-informed decisions about medium to long-term allocation choices. We are going to build a simple algorithm for understanding how investment decisions made using CAPE valuations would have historically performed.
There has been quite a bit written about what the proper long-term CAPE ratio to use as a baseline is given evolving market dynamics, economic regimes, etc. We like to look at backwards-looking, rolling 30-year windows. We believe this helps to adjust for some of these issues. We see what percentile the CAPE ratio is in vs. the range of readings within the past 30 years. We bucket these percentiles into deciles to simplify the final analysis summary.
The table below shows the average yearly S&P 500 returns from 1957 through 2024 based on what decile the CAPE reading was at the beginning of January of each year. Specifically:
- Col 1 is the decile we are analyzing
- Col 2 shows the average yearly S&P 500 return when the CAPE was < the decile
- Col 3 shows the average yearly S&P 500 return when the CAPE was >= the decile
For example, if you look at Decile: 2, the table is saying the average yearly S&P 500 return was 16.5% whenever you invested when the CAPE ratio was below the 20th percentile of the past rolling 30 years. It was 11.1% whenever you invested when the CAPE ratio was greater than or equal to that level. The overall average annual return of the S&P 500 during this time period was 11.8%.
Table 1: Arithmetic Average Annual S&P 500 Returns Based on Rolling 30y CAPE Decile
| Decile | Avg. S&P Return < Dec | Avg. S&P Return >= Dec |
| 1 | 22.8% | 10.8% |
| 2 | 16.5% | 11.1% |
| 3 | 16.9% | 10.9% |
| 4 | 14.6% | 11.1% |
| 5 | 14.3% | 11.0% |
| 6 | 15.8% | 9.1% |
| 7 | 14.0% | 10.0% |
| 8 | 13.8% | 8.1% |
| 9 | 12.0% | 11.1% |
Disclosures: For educational purposes only. Not investment advice. Past performance is not indicative of future returns. Investing involves risk, including the loss of capital. Rolling 30-year decile analysis by Kangpan & Co., data compiled from Damadoran’s “Historical Returns on Stocks, Bonds and Bills: 1928-2024″ and Schiller’s “US Stock Price, Earnings and Dividends as well as Interest Rates and Cyclically Adjusted Price Earnings Ratio (CAPE) since 1871” datasets.
Key Insight:
The data suggests increasing S&P 500 allocations when the CAPE is undervalued is more impactful than decreasing allocations when the CAPE is overvalued
There are a few things about this chart that stand out to us:
- All Avg. S&P Return < Dec numbers (Col 2) are higher than the long-term average of 11.8% during the full time period; this suggests it is more important to capture the upside when the stock market is undervalued vs. trying to eliminate the downside risk when the market appears overvalued
- The 3.4% underperformance relative to the overall 11.8% average of investing when the CAPE is >= Decile 8 is less than the 5.4% outperformance of investing when the CAPE is < Decile 3; once again, supporting the point that it is more impactful to capture the upside of the market when it is undervalued vs. trying to protect the downside
- That said, this analysis suggests there is still a significant, quantifiable underperformance relative to historical average returns of 3.4% that can be avoided when the CAPE is >= Decile 8; however, the follow-up question is whether the alternative investment options available (in this case, 10-year treasury bonds) are expected to return more than 8.1% a year whenever the CAPE is in this range. We will look at this dynamic more closely in a future post.
What About Protecting Against Crashes?
The table below shows the largest drawdowns in the S&P 500 by calendar year from 1957-2024 and whether those drawdowns occurred while the CAPE ratio was within a given decile. This view is useful for understanding which drawdowns could have been avoided by not investing in the S&P 500 when CAPE ratios were >= Decile X.
For example, the table shows that the -11.9% drawdown in 2001 occurred when the CAPE ratio was in the 9th decile. However, the -22.0% drawdown in 2002 occurred before the CAPE ratio reached this level. Meaning, a strategy that avoids investing in the S&P 500 when the CAPE ratio is at 9th decile would not have protected against that particular event.
Table 2: S&P 500 Drawdowns Averted By Decile
| Year | Drawdown | Decile 9 | Decile 8 | Decile 7 |
| 2008 | -36.6% | |||
| 1974 | -25.9% | |||
| 2002 | -22.0% | X | X | |
| 2022 | -18.0% | X | X | |
| 1973 | -14.3% | X | ||
| 2001 | -11.9% | X | X | X |
| 1957 | -10.5% | X | ||
| 1966 | -10.0% | X | X | X |
| 2000 | -9.0% | X | X | X |
| 1962 | -8.8% | X | X | X |
| Crashes Avoided | 4/10 | 6/10 | 8/10 |
The most interesting thing to note about this analysis is that none of these decile cutoffs protected against the two largest calendar year crashes that occurred in 2008 and 1974 (though the Decile 7 and 8 cutoffs did offer some protection against the 2000-2002 Dotcom sequence of drawdowns). According to our analysis, you would have had to cut investments off at the 6th decile in order to avoid the 2008 crash and the 3rd decile to avoid every drawdown on this chart. Of course, the problem with expanding those cutoffs so far down means you are giving up substantial, long-term upside for this protection by not being invested in the markets.
These two tables tell us that the CAPE ratio in isolation is likely best used to understand when to increase allocations to the S&P 500 rather than when to avoid investing in it.
Reach out to us if you’d like to discuss this analysis in more detail or if you’d like schedule a complimentary 30-minute Portfolio Efficiency Diagnostic Preview if you’re interested in learning how our systematic processes could improve your portfolio’s after-tax returns, optimize it’s reward-to-risk ratio, or incorporate an asset mix that better aligns to your long-term goals.
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Disclosures:
This content is for educational purposes only and is not investment, tax, or legal advice. Employees and clients of Kangpan & Co. may hold positions in securities discussed in this post. Speak with a licensed tax, legal, or financial advisor before making any changes to your investments or financial strategies. Past performance is no guarantee of future returns. Investing involves risk including the loss of capital.
Kangpan & Co. 