The CAPE ratio is widely considered to be a useful stock market valuation signal. So if you own a globally diversified portfolio then you may well be interested in good CAPE ratio by country data that can help you understand which parts of the world are under- and overvalued.

To that end I’ve collated the best global CAPE ratio information I can find in the table below. 

CAPE ratio by country / region / world

Source: As indicated by column titles, compiled by Monevator

A country’s stock market is considered to be overvalued if its CAPE ratio is significantly above its historical average. The converse also holds. Meanwhile a CAPE reading close to the historical average could indicate the market is fairly valued.

You should only compare a country’s CAPE ratio with its own historical average. Inter-market comparisons are problematic.

There’s more countries and data to play with if you click through to the original sources linked in the table. All sources use MSCI indices. Cambria uses MSCI IMI (Investible Market Indices). Research Affiliates derives US CAPE from the S&P 500. You can also take the S&P 500’s daily Shiller P/E temperature.

But what exactly is the CAPE ratio, what does it tell us, and how credible is it?

What is the CAPE ratio?

The CAPE ratio or Shiller P/E stands for the cyclically adjusted price-to-earnings ratio (CAPE).

CAPE is a stock market valuation signal. It is mildly predicative of long-term equity returns. (The CAPE ratio is even more predictive of furious debate about its accuracy).

In brief:

• A high CAPE ratio correlates with lower average stock market returns over the next ten to 15 years.

• A low CAPE ratio correlates to higher average stock market returns over the next ten to 15 years.

The CAPE ratio formula is:

Current stock prices / average real earnings over the last ten years.

To value a country’s stock market, the CAPE ratio compares stock prices and earnings numbers in proportion to each share’s weight in a representative index. (For example the S&P 500 or FTSE 100 indices).

But company profits constantly expand and contract in line with a firm’s fortunes. National and global economic tides ebb and flow, too.

So CAPE tries to clean up that noisy signal by looking at ten years’ worth of earnings data. For that reason CAPE is also known as the P/E 10 ratio.

What can I do with global and country CAPE ratios?

The CAPE ratio has three main uses:

• Some wield it as a market-timing tool to spot trading opportunities. A low CAPE implies an undervalued market. One that could rebound into the higher return stratosphere. Conversely, a high CAPE ratio may signal an overbought market that’s destined for a fall.

• Similarly, CAPE – and its inverse indicator the earnings yield (E/P) – may enable us to make more sensible future expected return projections.

• High CAPE ratios are associated with lower sustainable withdrawal rates (SWR) and vice versa. So you might decide to adjust your retirement spending based on what CAPE is telling you.

But is CAPE really fit for these purposes?

Well I think you should be ready to ask for your money back (you won’t get it) if you try to use CAPE as a market-timing divining rod.

But optimising your SWR according to CAPE’s foretelling? There’s good evidence that can be worthwhile.

How accurate is CAPE?

It’s certainly more predictive of negative energy than being told by a woman in a wig that you’re a Pisces dealing with a heavy Saturn transit.

But the signal is as messy as mucking about with goat entrails.

The table below shows that higher CAPE ratios are correlated with worse ten-year returns. Notice there’s a wide range of outcomes:

Source: Robert Shiller, Farouk Jivraj, The Many Colours Of CAPE

The overall trend is clear. But a market with a high starting CAPE ratio can still deliver decent 10-year returns. Equally, a low CAPE ratio might yet usher in a decade of disappointment.

When it comes to hitting the bullseye, therefore, the CAPE ratio looks like this:

Portfolio manager Norbert Keimling has dug deeper. His work showed that the CAPE ratio by country explained about 48% of subsequent 10-15 year returns for developed markets.

Source: Norbert Keimling, Predicting Stock Market Returns using the Shiller CAPE

You can see how lower CAPE ratios line up on the left of this graph with higher returns, like prom queens pairing off with jocks.

There’s no denying the trend.

Not all heroes wear a CAPE

Strip away the nuance and you could convert these results into an Animal Farm slogan: “Low CAPE good. High CAPE bad.”

However animal spirits aren’t so easily tamed!

Keimling says the explanatory power of CAPE varies by country and time period. For example: 

• Japan = 90%
• UK = 86%
• Canada = 1%
• US = 82% since 1970
• US = 46% since 1881

Despite such variation, however, the findings are still good enough to put CAPE in the platinum club of stock market indicators. (It’s not a crowded field).

In his research paper Does the Shiller-PE Work In Emerging Markets, Joachim Klement states:

Most traditional stock market prediction models can explain less than 20% of the variation in future stock market returns. So we may consider the Shiller-PE one of the more reliable forecasting tools available to practitioners.

But I wouldn’t want to hang my investing hat on World CAPE’s 48% explanation of the future.

Nobody should bet the house on a fifty-fifty call.

Don’t use CAPE to predict the markets

Let’s consider a real world example. Klement used the CAPE ratio to predict various country’s cumulative five-year returns from July 2012 to 2017.

As a UK investor, the forecasts that caught my eye were:

• UK cumulative five-year real return: 43.8%
• US cumulative five-year real return: 24.5%

The UK was approximately fairly valued according to historical CAPE readings in 2012. The US seemed significantly overvalued. 

Yet if that signal caused you to overweight the UK vs the US in 2012, you’d have regretted it:

Source: Trustnet Multi-plot Charting. S&P 500 vs FTSE All-Share cumulative returns July 2012-17 (nominal)

From these returns, we can see that the ‘overvalued’ S&P 500 proceeded to slaughter the FTSE All-Share for the next five years. (In fact it did so for the next ten.)

As a result, CAPE reminds me of my mum warning me that I was gonna hurt myself jumping off the furniture. 

In the end she was right. But it took reality a while to catch up.  

Using the global CAPE ratio to adjust your SWR

The CAPE ratio is best used as an SWR modifier.

Michael Kitces shows that a retiree’s initial SWR is strongly correlated to their starting CAPE ratio:

A high starting CAPE ratio1 maps on to low SWRs. When the red CAPE line peaks, the blue SWR line troughs and vice versa. 

William Bengen (the creator of the 4% rule) concurs with Kitces’ findings: 

And Early Retirement Now also believes a high CAPE is a cue to lower your SWR.

However all these experts base their conclusions on S&P 500 numbers. Can we assume that CAPE ratio by country data is relevant to UK retirees drawing on a globally diversified portfolio?

Yes, we can.

Keimling says:

In all countries a relationship between fundamental valuation and subsequent long‐term returns can be observed. With the exception of Denmark, a low CAPE of below 15 was always followed by greater returns than a high CAPE.

Likewise, Klement found:

Shiller-PE is a reliable indicator for future real stock market returns not only in the United States but also in developed and emerging markets in general.

Michael McClung, author of the excellent Living Off Your Money, also advises using global CAPE to adjust your SWR.

The spreadsheet that accompanies his retirement book does the calculation for you. You just need to supply the World CAPE ratio and an Emerging Markets CAPE figure. Our table above does that.

Incidentally, one reason I included three sources of CAPE ratio in my table is to show there’s no point getting hung up on the one, pure number. Because there’s no such thing.

Meanwhile, Big ERN has devised a dynamic withdrawal rate method based on CAPE.

Conquering the world

Finally, if you want to use Bengen’s more simplistic Rules For Adjusting Safe Withdrawal Rates table shown above, you’ll need to translate his work into global terms.

Bengen’s over/under/fairly valued categories assume an average US historical CAPE of around 16.

You can adapt those bands to suit your favourite average from our CAPE ratio by country table.

Bengen’s work suggests that a CAPE score 25% above / below the historic average is a useful rule-of-thumb guide to over or undervaluation.

A base SWR of 3% isn’t a bad place to start if you have a global portfolio. Check out this post to further finesse your SWR choice.

Take it steady,

The Accumulator

1. The CAPE ratio is labelled Shiller CAPE in the graph. [↩]

Useful asset classes are low cost, readily understood, easily tradable, and exhibit one or more of the following characteristics:

• A long-term track record of delivering positive real returns
• Diversifying properties that lower your portfolio’s overall risk
• Can protect your wealth during bouts of inflation or deflation
• Investable using accessible, liquid, low-cost index-tracking funds or ETFs.

By those criteria, commodities are a shoo-in.

• In part one of this series we explained how commodities investing works
• In part two we covered commodities’ long-run returns

Now let’s dive into the difference that commodities diversification has made to UK investment portfolios.

Many happy returns

The chart below shows how various 60% equity portfolios performed when diversified with varying commodities allocations. The latter’s share ranges from 0% to 40%:

Data from Summerhaven1, S&P GSCI TR, BCOM TR, JST Macrohistory2, JP Morgan Asset Management, The London Bullion Market Association, Measuring Worth and FTSE Russell. June 2023.

As the cyan line shows, the portfolio without commodities – the regular old 60/40 equities/gilts portfolio – comes dead last. Even more shockingly, the 60/40 equities/commodities portfolio leads the pack.

What gives?

Investing returns sidebar – All returns quoted in this piece are real annualised total returns. That is, they’re the average annual return (accounting for gains and losses) realised in a given time period. These returns include the impact of reinvested dividends and interest, but strip out the vanity growth delivered by inflation that does nothing to boost your actual spending power. Dollar returns for commodities have been converted to GBP.

How an allocation to commodities improves portfolio diversification 

The tables below show the difference commodities diversification makes in greater detail for passive investment portfolios.

We look at annual returns from 1934-2022, because this is the longest time period we have investable commodity data for. 

60% equity portfolios and commodities diversification

The engine of each portfolio is 60% UK equities. Diversification is provided by various allocations to government bonds (gilts), commodities, cash, and gold, as shown in the next table.

I’ve also included a 100% equities portfolio for comparison. Each portfolio is rebalanced back to its target asset allocations at the end of each year.

e = equities, b = bonds, c = commodities, ch = cash, g = gold 

The portfolio with the best annualised return is the 60/40 equities/commodities mix. This asset allocation even beats 100% equities into a cocked hat. 

Moreover, the 60/40 commodities-diversified portfolio earns a superior return with considerably less whipsaw volatility than its 100% equities rival.

I’ve used the Sharpe ratio to measure the risk/reward trade-off. The higher your Sharpe ratio, the better your risk-adjusted returns. Or, the more return you get per unit of risk as measured by volatility3. 

The 60/40 equities/commodities load-out has the highest Sharpe ratio in the table. That makes it the most rational portfolio of the set, if you believe that investors should choose the portfolio which offers the greatest return for a given level of volatility. 

The worst return row further demonstrates that high commodities allocations have mitigated some of the UK’s severest investing tests of nerve on record. 

Meanwhile the least volatile portfolio also happens to be the most diversified: 10% bonds, 10% commodities, 10% cash, 10% gold.

But that stability was achieved at the expense of return, compared to portfolios with higher commodity allocations. 

Curb your enthusiasm

On the face of it, ditching gilts4 for commodities led to a better outcome on every metric: whether that be average returns, volatility, or the Sharpe ratio.

But I’m not selling my bonds yet. I’ll explain why shortly.  

It’s also fair to say 100% equities doesn’t look worth the risk. The same would be true if we substituted global returns for the UK stock market, incidentally.5

In contrast, the better diversified 60/20/20 portfolio experiences much lower volatility than 100% equities. And it achieves much the same return.

80% equity portfolios and commodities diversification

e = equities, b = bonds, c = commodities 

Once again, the key metrics improve as gilts are elbowed out of the portfolio by commodities. 

Notice though, that while 80/20 equities/bonds is better than the comparable 60/40 portfolio, 80/20 equities/commodities is worse than 60/40 equities/commodities. Especially in terms of the risk-reward ratio.

The mildly negative correlation between commodities and equities reduces volatility, and also generates a rebalancing bonus.

There was no need to keep upping the equity ante in pursuit of return when commodities were part of your portfolio mix over this particular timeframe.

Intriguingly, commodities’ long-term return was lower than equities from 1934-2022. But the two assets combined, outstripped equities alone. 

50% equity portfolios and commodities diversification

e = equities, b = bonds, c = commodities 

The synergism between commodities and equities comes to the fore again with a 50/50 asset allocation. 

I have to counsel though that we can’t necessarily expect the two assets to play together quite so nicely in the future. That is why I don’t advocate ditching bonds. 

Rounding error fans should note that the 50/50 equities/commodities portfolio actually achieved a 5.96% annualised return versus 6.04% for 60/40 equities/commodities. That’s why the latter portfolio has a slightly higher Sharpe ratio. 

Interestingly, the 50/30/20 lock-up delivers the lowest volatility so far, along with a highly respectable annualised return. 

But if limiting the downside is your thing, just wait until you see the Permanent Portfolio results.

The Permanent Portfolio, but replacing gold with commodities

e = equities, b = bonds, c = commodities, ch = cash, g = gold 

The first column shows the standard Permanent Portfolio formulation of 25% equities / 25% bonds / 25% cash / 25% gold. This all-weather blend is hailed for its low volatility, wealth-preserving qualities. But its low long-term returns make it hard to recommend for most. 

Our second column swaps out gold for commodities. Now volatility rises just a smidge, but a significantly higher annualised return helps the portfolio to a 0.42 Sharpe ratio.

That’s the equal of anything else we’ve looked at today. Go tell the gold bugs!

When do commodities work?

The answer to this question explains why I won’t be swapping all my bonds for commodities (although I probably will exchange some).

Commodities have tended to work best during periods of economic expansion and rising inflation. See this table from the research paper Commodities for the Long Run by Levine, Ooi, Richardson, and Sasseville:

Excess returns in USD for an equal-weighted commodities index.

The table also shows that commodities typically underperform in recessionary and falling inflation rate environments. 

Note, the table traces broad trends, but it isn’t saying commodities will automatically perform on cue.

For example, commodities added to investor’s woes during the Global Financial Crisis and the Great Depression. But they were a healing balm during the Dotcom Bust and 1972-74 oil shock (the latter a hideous stagflationary amalgam of economic torpor and galloping inflation). 

Think different

As passive investors we shouldn’t be tactically trading commodities every time there’s a recession warning. We’re interested in the strategic benefits each asset class can bring to our portfolio.

So it’s good to know that the findings above are also confirmed by other researchers who’ve investigated long-term commodity returns. These include Bhardwaj, Rajkumar, and Rouwenhorst (see The Commodity Futures Risk Premium: 1871–2018), and Dimson, Marsh, and Staunton (see the Credit Suisse Global Investment Returns Yearbook 2023). 

To that we can add Monevator’s findings about the unpredictable performance of diversifiers in UK investment portfolios in part two of this series.

On that measure, commodities improved portfolio outcomes 58% of the time when equities retreated, but actually made matters worse in 42% of downturns. 

To sum up our diversification dilemma: government bonds defend against recessions. Commodities typically don’t. 

And commodities are a partial hedge against inflation, whereas nominal bonds most definitely are not. 

That’s why I want both asset classes in my portfolio. 

What should my commodities asset allocation be?

Now you’re asking.

The optimal asset allocation can only be known in retrospect, because it’s dependent on unknowable variables.

Think future returns, the future correlation of asset class returns, and your particular blend of assets. 

Various sources offer a future expected excess return for commodities of 3%, so we might expect a 3.5% to 4% total return.

But expected returns are to be taken with a pinch of salt. 

Dimson, Marsh, and Staunton explain why nailing the right asset allocation is like trying to pin the tail on a donkey:

The optimal allocation to futures depends on the investor’s tolerance for risk. For an investor who was comfortable with the risk of a 60:40 equity: bond portfolio, they [Erb and Harvey] show that the optimal allocation would be 18% in commodity futures, 60% in stocks and 22% in bonds. Unsurprisingly, the optimal allocation to futures depended on the expected excess returns. With an expected excess return of 1%, the optimal allocation to futures fell to 3%.

Vanguard’s take is that a future optimal commodities asset allocation could lie anywhere from 0% to 15%. That’s according to its paper Commodity Investing and its Role in a Portfolio. 

But Vanguard’s base case scenario suggests an allocation to commodities of less than 5%, which is almost as good as saying: “don’t bother.”

Stock puppets

At this point, you might be throwing up tour hands and thinking, “I’ll just get my commodities exposure through commodity stocks.”

Sadly, Dimson, Marsh, and Stauton cite evidence that this won’t work:

…investors may also gain exposure to commodities through their equity investments, e.g. in mining, energy and agriculture-related stocks. GR [Gorton and Rouwenhorst] investigated this by comparing the performance of commodity futures with commodity company stocks. They concluded that the latter behaved more like other stocks than futures. They were not a close substitute. 

Commodity of errors

As you can probably tell, there’s no right answer. But returning to our original criteria for an investable asset class, let’s review the positive case for commodities:

• A long-term track record of delivering positive real returns? Yes!
• Diversifying properties that lower your portfolio’s risk? Yes!  
• Can protect your wealth during bouts of inflation or deflation? Inflation, sometimes
• Investable using accessible, liquid, low-cost index-tracking funds or ETFs? Yes!

The fail for broad commodities ETFs is they are not readily understood (albeit you could argue the same is true for bonds and gold).

On those grounds, plus the imperative to keep things as simple as possible – but no simpler – I wouldn’t blame anyone for saying, “Thanks, but no thanks,” to commodities. 

However, for an engaged passive investor like myself, I believe the case for commodities is compelling. Assuming I can find the right passive fund to invest in, of course. I’ll report back on this in part five of our series. 

But none of this means I won’t be unlucky. The optimal allocation to commodities could be zero during my investing lifetime. But I can only know that after the fact. That’s investing risk for you. 

Coming around to commodities

Here’s where I am at…

Equities have a higher long-run risk premium than commodities and so should be the portfolio mainstay. 

There’s a clear rationale for why commodities should be able to deliver a reasonable rate of return in the future, but nothing is guaranteed. 

Commodities are an attractive strategic diversifier due to their historically low correlation with equities and bonds.

The limits of a vanilla 60/40 portfolio were hammered home as if by a hammer-wielding maniac by the events of 2022. And we’ve previously deep-dived the benefits of a more diversified portfolio. 

I’m particularly keen on not being solely dependent on my bonds for diversification – just in case we’re on the wrong end of a rising interest rates bond super-cycle. 

I’d also like to be less reliant on equities for growth. Multi-decade bear markets can affect this asset class, too.

So the fact that commodities deliver good long-term returns and offer some insulation from inflation is another big tick for me. 

I’m also a fan of owning every useful asset class in reasonable amounts. 

Less than 10% in commodities appears to me next to irrelevant, but I don’t think I’m brave enough to own 20%. 

I haven’t fully made up my mind yet. It’ll depend on how convincing I find the available broad commodities ETFs once I’ve completed my research into those. 

Either way, I’ll probably ease my way into commodities slowly. Perhaps 5% of the portfolio at a time, over the course of a year or so.

In the meantime, I want to dig into how well commodities stack up as an inflation hedge for UK investors. So that’s next in the series. (Subscribe to ensure you see it.)

Take it steady,

The Accumulator

1. Bhardwaj, Geetesh and Janardanan, Rajkumar and Rouwenhorst, K. Geert, “The First Commodity Futures Index of 1933,” Journal of Commodity Markets, 2020. [↩]
2. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
3. i.e. annualised standard deviation [↩]
4. UK government bonds. [↩]
5. We can’t get global equity returns before 1970. And the UK stock market’s longer track record enables our comparison to encompass a wider range of economic conditions. But UK returns are broadly in line with global returns and are probably a better benchmark than exceptional US returns that may not be repeated in the future. [↩]