For most of the 2010s, the CAPE ratio, one of the best-known yardsticks of whether U.S. stocks are expensive, kept pointing to trouble while the market kept climbing. A September 18, 2026 working paper from Federal Reserve Board economist Dino Palazzo traces those false alarms mainly to accounting rules and proposes a corrected gauge called CAPE-H.
Where it stands: The paper’s data stop in December 2025. At that point, it found the original CAPE ratio and CAPE-H both above their 97th historical percentiles, meaning stocks were priced higher relative to long-run profits than in almost all of their past. Its model put the chance of a five-year “correction,” a term the paper defines narrowly (see below), at 61.8% with the original measure and 60.0% with CAPE-H. These figures are end-of-2025 estimates from one research model, not a reading for today, not a forecast from Security Pension and not advice.
What the CAPE ratio measures, in plain terms
A price-to-earnings ratio compares what investors pay for a company with the profit it makes. The CAPE ratio, short for cyclically adjusted price-to-earnings, applies that idea to the U.S. stock market as a whole, with one twist: instead of one year of profits, it uses the average of the past ten years, adjusted for inflation. A decade-long average stops a single boom or recession from distorting the picture. Yale economist Robert Shiller developed the measure with John Campbell, and his public data series goes back to January 1871.
Research by Campbell and Shiller found that price-earnings ratios help forecast future stock price changes, and Palazzo notes that CAPE now feeds into investment decisions and into central banks’ financial stability assessments. A high reading means investors are paying more for each unit of long-run profit.
Why the CAPE ratio sounded false alarms for a decade
From 2011 through 2020, the paper finds, CAPE ranked mostly in the upper quarter of its own history, from roughly the 75th to the 98th percentile. Put simply, stocks looked more expensive than in most of the past, and CAPE kept signalling a raised risk of a poor multi-year stretch. Those poor stretches did not show up. Instead, from January 2011 until the peak just before the pandemic in February 2020, the S&P 500 more than doubled. Palazzo calls it a “sustained period of false alarms” that “materially weakened CAPE’s credibility as a forward-looking valuation indicator.”
The paper’s explanation is accounting rather than a misbehaving market. Two rule changes made reported company profits look smaller than they used to, and smaller profits make the same stock prices look more expensive:
- Research costs. Since a 1974 accounting standard, FASB Statement No. 2, U.S. companies have had to deduct research and development (R&D) spending from profit in the year they spend it, even when the research keeps paying off for years. As technology and drug companies became a bigger part of the economy, that rule took a bigger bite out of reported profits.
- One-time charges. Accounting standards adopted in the mid-1990s set out how companies record layoff and restructuring costs and write down the value of assets. These charges, often reported as special items, became much more common afterwards and tend to bunch up in downturns, dragging the ten-year profit average down for years.
The paper measures the effect directly. Before December 1991, reported profits under U.S. accounting rules (known as GAAP, for generally accepted accounting principles) averaged 82.8% of profits measured before R&D and special items. Afterwards, they averaged only 66.4%.
CAPE-H: the corrected measure
Palazzo’s fix, CAPE-H (the H stands for historically comparable), keeps everything about the original except the profit number. It adds R&D spending back and takes special items out, so that older and newer profits are measured on the same basis. The paper presents it as a consistency fix, not an estimate of what companies really earn.
| Comparison | Original CAPE | CAPE-H |
|---|---|---|
| Profit figure used | Reported (GAAP) profit | Profit before R&D and special items |
| Average level after 1991 | 27.6 | 19.3 |
| Where it ranked, 2011–2020 | 75th to 98th percentile | High-30s to low-90s percentile |
| Five-year correction odds (model), January 2015 | 47.1% | 29.4% |
| Five-year correction odds (model), December 2025 | 61.8% | 60.0% |
The fix narrows the gap without making stocks look cheap. After 1991, the original averaged 27.6 and CAPE-H 19.3, a gap the paper puts at approximately 43%. CAPE-H itself still rose: its median was 14.1 before December 1991 and 19.1 since, a rise of 36%. Palazzo’s reading is that stock valuations move in long cycles; across 145 years of data, the paper’s model gives high-valuation periods an expected length of 10.3 years. On that view, recent readings are high within historical ranges rather than a permanent new normal or unheard-of overvaluation.
How the study defines a correction and a crash
These words carry narrow meanings in the paper, different from how they are used in everyday market news. Palazzo looks at the S&P 500’s total change over a set period of one, three or five years. A correction is a period whose change ranks among the worst 25% of all such periods in the historical record. A crash is one among the worst 10%. A five-year correction, then, means five years of results as poor as the bottom quarter of past five-year periods, not a quick slide in prices.
The paper tests each horizon separately, and the results differ:
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- One and three years: CAPE-H helped predict both corrections and crashes. The paper reads this as high valuations making markets more fragile in the near term.
- Five years, corrections: the signal grew stronger. Among the most expensive fifth of starting points, the five-year correction rate reached 46%, compared with 25% across all periods.
- Five years, crashes: the signal broke down, and CAPE-H’s crash forecasts did worse than a simple benchmark. Palazzo attributes this to the difference between valuations settling back gradually and sudden shocks “whose timing remains inherently unpredictable.”
Why the time horizon matters for retirement savers
Investor.gov, the investor-education site of the U.S. Securities and Exchange Commission, defines a time horizon as “the expected number of months, years, or decades you will be investing to achieve a particular financial goal.” It says an investor with a longer one may be more comfortable with volatile investments because they “can wait out slow economic cycles and the inevitable ups and downs of our markets.”
Palazzo’s horizon results fit that picture in a particular way. The valuation signal the paper finds is clearest for slow, grinding weakness measured over five years, and weakest at pinning down a sudden collapse over the same span. For someone still building savings, five years is only part of the time their money may stay invested. For someone already drawing an income, a weak stretch early in retirement can matter more than the long-run average, which is the problem described in our guide to sequence of returns risk. Neither group gets a date from this research, and the paper does not offer one.
The same SEC guide describes the general tools for living with market risk. It defines diversification as “The practice of spreading money among different investments to reduce risk,” and explains that “Rebalancing is bringing your portfolio back to your original asset allocation mix.” The right mix for any one person, it says, depends largely on “your time horizon and your ability to tolerate risk.” We cover the basics in why diversification is one of the best investment strategies and look at the trade-offs in what happens if you stay in the stock market after retirement.
What the paper does not say
- It is not a timing signal. On the paper’s own tests, valuations did not help forecast five-year crashes, and the elevated correction probability is a model estimate, not a date.
- It is not personal advice. The paper studies the overall U.S. market. It says nothing about any individual workplace plan, IRA or pension, and Security Pension is not suggesting changes to any of them.
- It is not the Federal Reserve’s view. Palazzo is a principal economist at the Board, but a footnote in the paper says the Board of Governors and its staff do not necessarily share the views in it.
- It is not current data. The sample ends in December 2025. The 61.8% and 60.0% figures describe that month, not October 2026.
- It is a working paper. Working papers can be revised, and later versions may report different figures.
Shiller’s own data site makes a similar point about the series it publishes, saying it is “not intended to be a forecast of future events, a guarantee of future results or investment advice.” The paper’s full text is on SSRN, and the Federal Reserve Board publishes a profile of the author.
Frequently Asked Questions
What is the CAPE ratio in simple terms?
It compares the price of the U.S. stock market with the average of the last ten years of company profits, adjusted for inflation. Robert Shiller developed it with John Campbell. A higher number means investors are paying more for each unit of long-run profit.
Does a high CAPE ratio mean the stock market is about to crash?
Not on any predictable timetable, according to this paper. Palazzo finds that the corrected measure, CAPE-H, helps predict crashes over one and three years, but over five years its crash forecasts did worse than a simple benchmark. In the paper, a crash means the S&P 500’s cumulative change over the period ranks in the worst 10% on record, and the timing of such shocks is described as inherently unpredictable.
Why did the CAPE ratio give false alarms in the 2010s?
The paper argues that accounting rules made reported profits look smaller: R&D spending must be deducted right away under a 1974 standard, and one-time write-downs became more common after rule changes in the mid-1990s. Smaller profits made the ratio look higher, while the S&P 500 more than doubled over the decade before the pandemic.
Should retirees change their investments because of the CAPE ratio?
This paper does not address individual portfolios and gives no investment advice; it reports model estimates for the overall market through December 2025. Investor.gov ties a suitable asset mix to each person’s time horizon and tolerance for risk. A licensed financial professional can help apply that to your own situation.
Is CAPE-H the Federal Reserve’s official view?
No. CAPE-H comes from a working paper by Dino Palazzo, an economist at the Federal Reserve Board, and the paper says its views are the author’s alone, not necessarily those of the Board or its staff.
Sources
- The CAPE That Cried Wolf (version dated September 18, 2026) — Dino Palazzo, Federal Reserve Board (working paper, SSRN), September 18, 2026
- Dino Palazzo: Meet the Researchers — Board of Governors of the Federal Reserve System, page last updated February 26, 2026
- Shiller Data — Robert J. Shiller, accessed October 10, 2026
- Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing — Investor.gov, U.S. Securities and Exchange Commission, accessed October 10, 2026
This article is for general information only and is not investment, tax or legal advice. Security Pension does not recommend buying or selling any security, and nothing here predicts what any market will do. It summarizes a working paper by a Federal Reserve Board economist; the paper states that its views are the author’s own and not those of the Board of Governors or its staff. Talk to a licensed professional before making a financial decision.