CAPE Ratio explains: Why this one metric predicts whether stocks are overvalued

This one metric tells you whether markets are overvalued. Huber's thesis shows: CAPE > 30 leads to crashes. Understand the logic.

What is the CAPE ratio?

CAPE = Cyclically Adjusted Price Earnings Ratio. It is the "smoothed" version of the P/E ratio that takes into account average earnings over the last 10 years.

The formula:

CAPE = Stock Index Price / (Average Inflation-Adjusted Gains Over 10 Years)

The advantage: CAPE filters out cyclical profit fluctuations and shows the structural valuation.

Historical reviews since 1881

Huber shows in his analysis (Figure 53): The S&P 500 has had an average CAPE of 16.6 since its inception. This is your baseline.

What do the numbers mean?

• CAPE < 15:Undervalued – good buying opportunity
• CAPE 15-20:Fair value – normal valuation level
• CAPE 20-25:Overrated – increased crash risk
• CAPE > 30:Extreme bubble – almost 100% certain crash is coming

Predictive power of CAPE

Huber analyzes the return distribution by CAPE level (Table 6). The result is bleakly clear:

The message is clear:The higher the CAPE, the lower the future returns. If you invest at CAPE > 30, you can only expect an annual return of 1.2%.

CAPE country comparison

Not all markets are equally overvalued. Huber analyzes the CAPE ratios of various countries (Table 5):

Conclusion:The USA is overvalued at CAPE 28.3. Europe and emerging markets offer cheaper entry points - that's a practical lesson from Huber's data.