What the Shiller P/E (CAPE) Can and Can’t Tell You

0:00We got an email from a listener named Chris and he was basically saying he's kind of stuck because the Cape is around 40 and everything that he is reading says that that means future stock returns could be very, very low for the foreseeable future. So why would he keep investing is what he's basically asking when he can go to CDs or even a high yield savings account T-bonds for four to five percent return when while he's reading is telling him that the stock market is going to give him one to three percent return. So today, Andrew and I are going to talk about what the CAPE is, what it means, what it measures, and how you can use it as a tool to plan for a better future for yourself financially.

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2:48something that I feel like doesn't get covered a lot. And we're going to be talking about CAPE, how it is a useful tool, but it's not a crystal ball. Today, we're going to explain what it is, what we can and cannot tell by using it as a tool, and how to make smart investing decisions with valuations that look kind of stretched in the long term. And Andrew, like, so I mean, just, I guess the first thing we need to cover CAPE, cyclically adjusted price to earnings is what it stands for um but i mean that that sounds super complex and complicated like what does cape actually mean what does it do basically um it's trying to set a valuation level for where the stock market is um and so a lot of times we use like price earnings ratio and a lot of people talk about is the market cheap is it expensive you look at a price earnings ratio.

3:47And sometimes it gives you a good sense of, okay, price earnings is a 40. It's expensive. Price earnings is a 10. It's cheap. What the Cape tries to do, which was, I believe created either created or popularized by Robert Schiller. So a lot of people call it the Schiller PE, but what it's trying to do is kind of take a longer term average. and so as we all know um earnings can fluctuate quite a bit they can be up they can be down the cape is trying to take a longer term view of those earnings and say okay uh these are more smoothed out earnings and so the fact that it's at like a 40 is historically very very high compared to previous years right and like historically over the past several decades is kind of varied between like 15 and 17.

4:41And so like Andrew's saying, right now it's like hovering around 40 to 41, which is insane, insanely high. So let's just cut straight to the chase then. With that cape being so high, does it still make sense to invest in stocks? I think it does. Personally, there's a lot of details we can dive into that a little bit later. But the big idea I would present right at the top is like, it will never be cheap enough for you. Like it will never be good enough. So you're not going to invest today. You're not going to invest in six months. You're not going to invest in two years. We all like to think that we're going to be able to time something perfectly, but reality is much harder.

5:33I don't know if in your journey, Stephen, like when you started as an investor, was timing kind of a thing? Have you looked at the expensiveness or the cheapness of the stock market? Or is this something you've never considered? I've honestly never even worried about it. I worry about the stocks that I'm buying, if the valuation is viable. But when it comes to like the market as a whole, uh, it's never even crossed my mind. Like I said, I knew what Cape was, um, before looking into it for this episode, but I never really even considered it relevant to me. Um, but I mean, it is a great question.

6:19Chris has me thinking and, you know, i don't have a good answer for it right now it's you know i need to kind of meditate on it um to sound woo woo but uh but i mean it's to me it's you know warren buffett's career spanned what 60 years so i mean and all he talks about is is being you know being in the market he always stayed in the market. And so to me, that means, you know, if I want to emulate him, I got to do the same thing, even though the Cape is high. What I don't really understand is, so is Cape like inflation? Is it just expensive right now? And then kind of like inflation, eventually our wages catch up to it so it seems like because inflation never actually goes down we just catch our earnings catch up to what inflation is so is cape kind of the same thing where where it's it is what it is and eventually the market's going to catch up to it or how does that even work that that would be the argument a lot of growth and high risk type investors would make is that yes the it may look expensive, but we have growth ahead that's going to work its way out.

7:46And now all of a sudden, it goes back to a reasonable level. Whether that's the case or not, I can't speculate. And just one of those things about, like I mentioned Warren Buffett and putting in context of a 60-year time horizon, we talk on the show a lot about people who are just starting in their wealth building journey or have decades of wealth building to accumulate their investments. And so with that in mind, there are going to be random 10-year periods. You pick one random year, you pick another random year, your returns will look awful. But to your point, as long as you're fully invested, you will have to ride the ups and downs, but over the long term, will be worth it.

8:37And trying to jump in and out. I've never heard of an investor who was successful in selling all the time that the Cape was high and buying all the time that the Cape was low. And actually on the extreme side of it, I've heard of value investors who thought the market was too expensive in 2016 and stayed out since 2016, 10 years ago. So this idea, Yeah. And I'm not trying to argue that the market's not expensive now. All I'm trying to say is having a philosophy or a way of doing things in the market where you're trying to react to the expensiveness or the cheapness of the market is not going to be a good outcome.

9:23because you're going to be jumping in and out and there have been very few successful market timers and none that I can really point to and say, yes, this person was successful with it. No, I agree. And I mean, that kind of leads to, you know, what is a CAPE good for? What can we use it for? And really, it's just kind of a long-term valuation tool. So, I mean, that's really all it is. But what you can't, or what it's not good for is, one, timing of the market. Like Andrew said, that's not going to be successful no matter what tool you use. And I think the biggest thing it's not good for is, you know, yes, Chris is reading 1 % to 4%.

10:18It took five seconds of Googling to find out what he's reading. And he's not wrong. That's what they're saying. One to four percent returns. That sucks. But that's an estimation. That's not an exact science. And that's just the experts trying to use their crystal ball to predict. The cape is a thermometer, not a calendar. So I mean, it's, I think more than anything, what Chris is reading is just fear mongering rather than exact science. Yeah, 100%. It's interesting too how the CAPE is constructed and how top heavy it is. basically from what I saw it the CAPE ratio it can be calculated different ways but the general way would look at all the profits of all the companies in the S &P 500 and then compare that with all of the market cap and so what you'll have is a company like Alphabet which by the way according to Finda's latest income or profit,$160 billion in one year.

11:35A company like that, massive scale, is tipping the CAPE ratio higher if it's one of those more expensive stocks. And so you have these, you know, the S &P 500 is comprised of hundreds of these really, really small companies and businesses, they are not being represented by this CAPE ratio because of the fact that the biggest ones are so big that they are really tilting the scales and making this CAPE ratio not represent the entire stock market. Let's move on to what is driving the CAPE up. So, I mean, is it interest rates? Is it the way the S &P is constructed? Is it simply just accounting over the next couple of decades?

12:34Like, what is driving the Cape so high? I'm sure that's a loaded question. yeah um well let's go back to my um big big companies list again these are these are going to drive the market in a very big way so nvidia apple and alphabet are all each four trillion dollar companies nvidia is approaching five trillion in market cap actually so the difference between that and let's say number 18 on the list is$4 trillion down to$600 billion. So again, it's just very, very top heavy. And so you have companies that are really expensive that are tilting that higher would be like Tesla. Tesla's at a 344 PE.

13:31Broadcom's at 64. four uh you have amd at 170 so these are massive peas you got micron too these are all companies in like the top 20 that are very very expensive pes and then the rest of the group is all generally expensive uh nvidia is at a 30 pe apple's at a 35 but then the other big factor in this is that the The PEs that we're seeing now that are reported are actually not fully represented in the CAPE either. Because remember, the CAPE is looking at a long-term average. So the CAPE is looking at 10 years. A lot of these companies like NVIDIA, I think you texted me a chart the other day of just how...

14:22What was the term you used? Was it not helicopter, but rocket ship that NVIDIA's profits has been? A lot of these profits are from such high growth that just a few years ago, these companies really weren't earning that much. And so while from a PE perspective, things look decently reasonable, the longer term is showing that like, hey, a lot of this growth is new. So then you go back to, I hate to always bring it back to this conversation because everybody's having it with every podcast on every stock market show in the world. But I think it all comes back to the AI discussion. Do you think that the profits and the profit levels that companies are at today, is that a step change?

15:07Is that sustainable and they're just going to keep climbing that ladder? Or is it an AI-fueled bubble that's going to pop and then shoot back down and then you have a lot of carnage in the stock market? So I think that combination of you have some really expensive stocks from a PE perspective, plus you have the biggest companies that have seen massive growth. And so 10 years ago, five years ago, they were not earning that much. I think both of those factors are playing into what we're seeing today with a really, really high CAPE ratio. I'm excited to share our friends over at the Plink app released a major upgrade featuring a sleek new look, real-time insights, smoother trades, and tools that help you feel more confident with every move.

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17:20Just use code CashApp10 when you sign up. And don't forget this part. Send at least$5 to a friend in the first two weeks. Terms apply. Cash App is a financial services platform, not a bank. Banking services provided by Cash App's bank partners. Bitcoin services provided by Block Inc. brand. For additional information, see the Bitcoin disclosures at cash.app.legal.podcast. What's the best way to get started in the market? Download my ebook for free at stockmarketpdf.com. Yeah, definitely. The only thing I would add to that is you got to remember perspective as well. Andrew touched on it a little bit.

17:55you know in 1980 one of my favorite tv shows andrew i don't know if you've ever watched it is uh the goldbergs um and it's about the 80s growing up in the 80s uh about a kid named adam goldberg it's a great show great family show um but one of the things that always like kicks me in the face is whenever they're like you know they're they're asking their parents for money and they're like yeah I want to get this it's only two hundred dollars and and their dad is like what you think I made of money blah blah acting like two hundred dollars is so freaking expensive and I'm like man I would love to live in a time when when two hundred dollars was expensive that would be awesome um but you know it's all perspective like I don't remember the 80s uh because i was too young but i mean yeah if you take a stock from today back to the 80s like it's going to be insane compared to what the stock market was the s &p 500 was in 1980 compared to today so you all you you have to kind of look at it through a lens of perspective as well you know 20 years from now like our stocks are going to look cheap compared to to what we're thinking at this very moment.

19:17So, I mean, it's all perspective to me. And that's kind of why I just kind of, as I was reading, I just kind of brushed it off as more fear-mongering than anything because they don't know for certain. And, you know, from that perspective lens, all we really truly care about is the S &P 500 going up and to the right and staying up and to the right. is that going to happen more than likely so i i'm fine i don't need to worry about it am i thinking about it wrong no i don't think so at all i agree with you it does seem like fear-mongering and i like that you're bringing out history too because we should look at history to look at not just what the s &p has done but how has the s &p done it uh warren buffett i think last year in the Berkshire meeting, or it might have been two years ago, he had a list and he showed the top 10 companies in the S &P 500.

20:17And then I think that was in like 2000. And then he looked again, 2010, or it might have been 2010, 2020, but it was a top 10 list. He compared the two. You only had two names that stayed on the list both times. You had Apple and you had Microsoft. And so what really happens when the S &P goes up and to the right is that, But yeah, a lot of the companies near the top that are expensive don't do that great and maybe stay flat or maybe go down. But there's like never fails. There's always a new crop of companies that are ready for their time in the sun. And they'll come up and they'll really dominate in ways that the old companies never did.

20:58And so, again, if we look at what are the companies that are at the top today, you have NVIDIA, Apple, Alphabet, Microsoft, and Amazon. where was Amazon five, 10 years ago? They weren't nearly as massive as they are today. They never, they didn't have a cloud business, you know, before 2014. They were a bookstore in, I believe, 2000, 2001, just a small little online bookstore. So it can be true that, yes, the market is expensive from a K perspective, but also, yes, there are going to be companies that bring the stock market higher because we're just not, they're not on our radar right now, but they're going to push, they're going to be the ones pushing everything forward and they will be the next Amazon or the next Apple or the next NVIDIA.

21:50One thread I want to pull on, you brought up the AI and whether or not it's a bubble. And again, we're not psychics. We don't have a crystal ball. We don't know. It could be like the dot-com bubble or it could be something that's here to stay. We just kind of got to do our research and guess the best we possibly can. But there are things you got to consider that I don't think a lot of people do whenever they're looking at AI. And one of the things that I just maybe last night or the night before last started to really think about, AI needs these data centers. it's mandatory it has to have them in order for it to grow but people freaking hate the data centers they don't want them in their communities they're big they're ugly they're energy hogs they don't want to look at them they don't want to hear them they don't want to be around them so these these massive companies are going to start losing abilities to build their data centers because eventually they're going to basically run out of real estate.

23:05Eventually, they're going to have to figure out a new way around these data centers and maybe building them underground. I have no idea what the solution would be, but that's a huge, massive hurdle for AI. How are these data centers going to get constructed? If they can't figure that out in the next decade, I think it's going to really hamper AI's growth. Now, does that mean they won't figure it out? Absolutely not. Because if it's one thing our market teaches us is innovation happens when innovation needs to happen. And so, I mean, but that's definitely something we have to consider. And I'm not trying to sidetrack the topic of CAPE, I guess, to circle it back.

23:54You know, AI stocks are crazy expensive now because of the way they're going. But, you know, if they can't figure out these data centers, watch them crash really quickly is my point. Oh, yeah, 100 percent. And there's research from McKinsey also talking about how that is the bottleneck is the data center build out, not necessarily other things. I've seen a couple of Instagram short, whatever you want to call them, skits, where people are like impersonating chat GPT like, oh, you know, you're right. I'm sorry. You know, I got it wrong or whatever. but like pouring out a glass of water every time it makes a prompt.

24:40I've seen multiple people doing that. The water usage is just insane for some of these things. And to your point, it's not making the general public very, we're not getting the happy feelings towards the water usage and some of the other things that these data centers are bringing. Well, you got to think about it too. the average person doesn't use ai that much um you and i use ai a lot because we're entrepreneurs you know we use it to help us with our work but you know you you go find a guy that pours concrete i guarantee you he don't give two craps about ai like it's not paying his bills it's not helping to make money, it doesn't help his life, so he doesn't care.

25:30And so I feel like AI's appeal to the general public as a whole is definitely a hurdle as well. So anyway, sorry to get us off on the AI tangent, but I guess what it comes down to at the end of the day, Andrew, is the real decision of where does my next dollar go then you know chris is looking at the cape it's freaking him out it's scaring him uh you know just just off his email i can tell that he's worried maybe scared is the wrong way word to use he's worried and so where should his next dollar go and i'm not saying we're not financial advisors um but if you were him well how would you look at it what would you think and what would your two to three year outlook be i i love the question and we have to make a few assumptions because we only got what he disclosed to us in the email but i'm going to make an assumption that whatever money he's scared to put in is is a substantial amount of money to him and that's why that's where some of this fear is coming in like if if we're talking about 100 bucks like i don't think there would be this level of concern that's a really good point if there's a big chunk of money and you're nervous and especially if you're like an investor for the very first time um i would say like take your time and and do it in steps like if it was me i remember i had times even as a podcaster and somebody who's written about the stock market for a long time there was a time when i had a a rollover of uh of a 401k and i did not feel comfortable just throwing that entire amount into the market all at once.

27:18And so I split it up in chunks and did it over time. Evan would probably run the numbers on Google Sheets and show me how I was wrong and how much more money I could have made if I did the right thing, because time in the market beats time in the market. But you do have to take into account that this is psychological and your behavior will always trump any of the logic that your brain tries to tell you. And so you need to be comfortable. We all need to be comfortable enough that when we put money into the market, that even if it turns the other way against us, that we're still confident that this is part of the plan.

28:00And I don't hear that from the email right here. I hear a level of worrying, concern that even if he did put money in now, he'd be looking at it every single day. And we can't be at that point as investors because then you're very likely to have poor results because you're just going to be too reactive. So one, what Andrew meant to say was time in the market beats time out of the market. You said time in the market twice. but yeah time in the market beats time out of the market any day um and the other thing another assumption and that's that was such a good point because i didn't think about the fact we have to make assumptions based off what he said because he didn't disclose a whole lot of information and one of the things is why he's investing is he investing for the short term um because he that money has plans elsewhere maybe he's buying a house in five years and he wants that money to grow while he's working towards buying that house.

29:05And if that's the case, maybe a high yield savings account is a good option. You know, you just kind of have to do the math and figure that out for yourself. Because like Andrew said, at the end of the day, if you're going to sit there and stare at your brokerage account all day, every day, that's just going to cause you stress. That's going to cause health issues. that's going to cause all things you don't want. And at the end of the day, we don't want that either. So for you, so, you know, figure out what your next best option is. However, the assumption I made was that he's looking for a long-term, maybe retirement type account.

29:46And if that's the case, we have to remember inflation plus compounding are always going to add up. And to me, when you take in those two factors, that's always going to make sense to put time into the market versus CDs, T-bills, obviously cash, long-term savings, anything like that. Yeah, I mean, it seems to me like this is a stock market's paradise. Wow, how many words can I screw up today? This is a stock picker's paradise. There are so many stocks that are cheap or reasonably priced. Really great businesses that are out there. And so just because the Cape is high doesn't mean you need to be buying stocks that are expensive either.

30:40So the market's not always like this, but every once in a while you get a divergence between the big stocks and some of the smaller ones. And there's a lot of small ones out there that are cheap. And I would argue very, very high quality businesses. But in middle 2026, if you're not in the AI trade, your profits don't matter. Again, being sarcastic. And so you can buy stocks outside of the AI trade and you'll probably do pretty well. That's what I'm doing with my money right now. And so I'm not worried about how expensive the market gets. I'm looking for the next opportunity. I mean, I think other people can, and Chris should think about that as well.

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32:48What can we expect to happen? I mean, just looking at the numbers, if the long-term CAPE is a 40, and if the CAPE is a 40 now and the long-term average is 17, then sure, I mean, stock market dropped 50%. If we have like a huge economic turmoil period, which is very possible, if you want to argue we're not there already, we could see CAPE down to like a 10. And so what would that do to the stock market now? You would have another decline of 50 % on top of a decline of a 50%. And so, yeah, that could be very, very painful.

33:35and so it's in those cases again you have to just consider what can i control what can't i control and just focusing on the things you can't control so the things you can't control as an investor is putting money into the market consistently every single month ideally staying invested for the long term and focusing on the opportunities that are in front of you and and not worrying too much if you're not making perfect decisions every single time. Again, building wealth is not a one-time event. It's not a game seven and then that's it. It's over. We're talking about your entire lifetime here. And so lots of investors have had 10-year periods that were not great, but they continued doing what they do and believed in the process.