Vanguard examines whether adjusting the CAPE ratio for interest rates improves long term U.S. equity return forecasts. The paper argues traditional valuation models became less effective after 1990, showing fair value CAPE measures explained nearly 70% of subsequent 10 year returns versus materially weaker results from standard CAPE frameworks.
Improving U.S. stock return forecasts: A “fair-value” CAPE approach
Vanguard
Joseph Davis
Research
15 Pages
Key Takeaways
Rates Drive Multiples: Falling bond yields helped justify structurally higher equity valuations, with fair value CAPE explaining nearly 70% of future 10 year returns.
Traditional CAPE Weakened: Standard CAPE forecasting relationships deteriorated after 1990 as lower rate environments supported elevated market multiples for decades.
Forecast Errors Reduced: The adjusted CAPE framework produced smaller forecasting misses during the dot com bubble and post 2008 recovery than conventional valuation models.
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