In my discussions with investors, the Cyclically Adjusted P/E (CAPE), or Shiller P/E, has come up numerous times as a risk for the U.S. stock market. The current reading of 32x is only exceeded by the peak during the NASDAQ Bubble, and it is higher than the levels seen before the Crash of 1929. Does this mean that the risk of a substantial stock market drawdown in the near future is rising?
I studied the question in the context of some of the criticisms of the Shiller P/E and made a number of adjustments to the calculation. I found that the answer is the same. The U.S. equity market is expensive, but Shiller P/E does not work well as a short-term market timing technique. However, I have found that the combination of valuation and price momentum can provide clear warning signs that the market is about to enter a bear market.