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Can We Use the Shiller CAPE Ratio to Forecast Country Returns? by Rich Shaner, CFA

Updated: Mar 8, 2023

Originally written on Alpha Architect. Read Here

Utilizing an Amended CAPE Ratio to Derive a Country’s Expected Return and Develop Portfolio Rotation Between Countries

  • Sailesh S. Radha

  • Journal of Portfolio Management

  • A version of this paper can be found here

  • Want to read our summaries of academic finance papers? Check out our Academic Research Insight category

What are the research questions?

We all became relatively aware of the CAPE ratio when Shiller predicted the 2000 internet bubble in his book “Irrational Exuberance,” then after he added a touch of robustness when he called the 2007 housing crisis(1) we all became intimately aware of it. Historically, the CAPE ratio, Shiller’s PE, has primarily be utilized over long periods of time and has expressed valuations as being undervalued, overvalued, or fairly valued. Similar to the paper previously covered by Tommi Johnson, Ph.D., in which CAPE is adapted to improve U.S. stock return forecasts, the author of this paper seeks to explore ways to sharpen the blade of the CAPE ratio to derive expected returns for countries in the MSCI Ex. USA World Index utilizing a measurement he calls, “Medium-Term Country Yield Forecasts” (CY-M).

The research questions are as follows:

  1. Can we utilize CAPE with supplemental measurements to develop a yield forecast measure for the medium term?

  2. Can the Medium Term Country Yield Forecast be utilized to screen and rank countries to construct an international country rotation portfolio?

What are the academic insights?

Utilizing data from the MSCI All Countries World Index ex. USA (ACWX) for the periods 1969 though 2016 the author finds the following:

  1. YES, CAPE can be utilized as a medium-term yield forecast tool by amending and improving the metric via the addition of the country’s cyclically adjusted real exchange rate (RER 10)(2) with a country’s trailing five-year momentum. By combining these measurements with inverse CAPE (1/CAPE) the author developed what he calls the “Medium-Term Country Yield Forecast.” (CY-M)(3)

  1. YES, when ranking countries in quintiles by CY-M(4) over a 38 year period stretching from January 1980 through December 2017 the spread in the alpha between the top and the bottom quintile is an average of 14.30% annually.

Why does it matter?

CAPE was initially developed for the US Equity Market and has been widely utilized in various markets outside the United States as well. In the adapted CAPE ratio the author has developed, CAPE is utilized to garner an expected yield of foreign countries and is suited for analyzing medium-term (2-10 year) international investing opportunities. Typically international investing and choosing countries to invest in thas been complex and challenging for small and medium-sized investors. Because of this complexity managers have been turning to single country ETF’s to garner exposure to international markets. By utilizing the CY-M ranking system investment managers have a guide that they can utilize to effectively select which countries to invest in and have annual rebalance guidelines for where to effectively allocate capital in the MSCI World index countries.

The author has also developed extremely helpful interactive charts of CY-M and images for you to utilize here.

The most important chart from the paper:

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.


The cyclically adjusted price-to-earnings ratio (CAPE), though originally derived for the US equity market, has now been calculated for various national equity markets outside the United States. In all its various adaptations, the measure has been used only to express valuations of those markets in terms of being overvalued, undervalued, or fairly valued. None of the adaptations of the measure have been used to derive finite equity return expectations from those markets. This article explores the approach of applying CAPE to develop a computable forecast measure, called the medium-term country yield forecast (CY-M), to express the medium-term real return expectations of national equity markets. In almost all of its past adaptations, CAPE has mostly been used to express only long-term (periods greater than 10 years) valuations of the equity markets, but the author here has explored its application in the medium term (periods between 2 and 10 years). Drawing conclusions from empirical studies on countries in the MSCI All Countries World Index ex. USA (ACWX) for the period 1969 through 2016, the author has amended the CAPE of a national equity market by coalescing it with the cyclically adjusted real exchange rate (computed in the same manner as CAPE) of the country and the long-term price return momentum (adjusted for inflation) of the market. The author also has applied CY-M derived from the adapted CAPE as a comparative measure to screen and rank countries in the ACWX to construct an international country rotation equity portfolio.


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