How the Shiller CAPE is built, why it compares prices with ten years of real earnings, and how Anacleto turns it into a signal with rolling thresholds.
The CAPE (cyclically adjusted price-to-earnings ratio), popularised by Robert Shiller, divides the price of the S&P 500 by the average of the last ten years of earnings, adjusted for inflation. Using a decade of earnings instead of one year smooths out booms and recessions, so the ratio reflects how much investors are paying for a normal year of profits.
Over long periods a high CAPE has been followed, on average, by lower returns over the next ten years, and a low CAPE by higher ones. The relationship is loose over a few months and stronger over a decade: the CAPE says little about next year and something about the next ten.
A fixed threshold would have flagged US equities as expensive almost continuously since the 1990s, because the average level of the ratio has drifted up (lower interest rates, different accounting, a different mix of companies). Anacleto therefore uses rolling thresholds computed on the previous 30 years:
The CAPE carries a weight of 1.5 in the sum of signals, the other thermometers 1. Data: Shiller's monthly series, updated once a day by the shared job.
The CAPE is US-only (S&P 500), while a world ETF also holds Europe, Japan and emerging markets. Historical earnings in Shiller's file are interpolated, so a back-test using them knows slightly more than an investor knew at the time. See how the rules turn signals into weights.