A MARTÍNEZ, HOST:
We have the story of an economic indicator that is causing concern. So of course, we turn to our colleagues at the Indicator from NPR's Planet Money. Here's Paddy Hirsch and Darian Woods.
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PADDY HIRSCH: The Shiller PE ratio.
LIZ ANN SONDERS: It was developed by Robert Shiller, who is an economist.
DARIAN WOODS: This is Liz Ann Sonders. She's the chief investment strategist at Charles Schwab. And she quite often consults the ratio, which is sometimes called the CAPE.
SONDERS: Cyclically adjusted price-to-earnings is CAPE. So it's often shortened to Shiller's CAPE.
HIRSCH: But Shiller didn't come up with this CAPE concept on his own, Liz Ann says.
SONDERS: Also, another economist, John Campbell, I'm not sure why his name is not attached to the metric.
JOHN CAMPBELL: Well, I think it should be the Campbell-Shiller CAPE, strictly.
HIRSCH: This is John Campbell, economics professor at Harvard.
WOODS: John and Bob Shiller came up with the CAPE in the 1990s, just ahead of the dot-com crash. It built on the age-old method of valuing a company with a PE, or price-to-earnings ratio.
HIRSCH: The price-to-earnings ratio is where you divide a company's stock price by its earnings per share. You compare whatever number you get to a bunch of other data about the sector. And that tells you whether the stock is cheap or expensive or Goldilocks.
WOODS: The CAPE ratio blows this concept wide open. And it applies to the entire S&P 500 and not just for the last year of earnings.
HIRSCH: Yeah, going back a whole decade takes volatility out of the question. Like, if you looked at the PE ratio for just 2020, when the pandemic made a royal mess of the market, you'd get a skewed number.
WOODS: Right now, John says the number is pretty darn high.
CAMPBELL: The CAPE ratio today is pretty close to 40. And that's higher than it's been at any other time besides the turn of the millennium.
HIRSCH: Before we all lose our minds, John says if you're looking to the CAPE number to tell you what's going to happen in the market tomorrow or in the next few weeks or even the next few months, you are looking at the wrong dial on the dash.
CAMPBELL: This isn't something that's going to tell you, oh, there's going to be a crash tomorrow. But if you look over 10 years, high values of this ratio are associated with low subsequent 10-year returns.
WOODS: In other words, when the CAPE number is high, returns tend to be lower over time. And when the number is low, returns tend to be higher, again, over time. This is a long-term predictor.
HIRSCH: But Liz Ann says that is not the way that a lot of people are reading the CAPE right now.
SONDERS: There's, in general, a concern right now about the market being in some sort of bubble, a little more of a AI-specific concern, but lots of comps to the late 1990s dot-com bubble.
HIRSCH: The comparisons are pointed, John says. As with the internet in the late '90s, a lot of companies are pouring a lot of money into a nascent technology with AI.
CAMPBELL: They can't all win. There may be one winner or even two. But there's not going to be five, six or seven winners.
HIRSCH: But guess what? Companies can grow into their valuations, and the market can, too.
WOODS: And this is why Liz Ann and John say that even though the CAPE ratio is the highest in a quarter century, it can't tell you anything about what's right around the corner. Ten years down the road, on the other hand?
CAMPBELL: If exuberance is a state of mind that tends to wear off gradually, then the exuberance that we see today is unlikely to still be there, say, in 10 years.
HIRSCH: Paddy Hirsch.
WOODS: Darian Woods, NPR News.
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