The table below lists the historical and current CAPE ratios of the largest equity markets in the world. Among the largest economies, the most expensive stock markets can be found from India, the U.S. and Japan. However, the CAPE ratios of different markets should not be directly compared to each other. The best way to evaluate if a country’s stock market might be undervalued or overvalued is to compare the nation’s current ratio to its historical average.

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Global CAPE Ratios by Country

*Negative earnings have been included when the CAPE ratios have been calculated which makes especially Italy’s past CAPE ratios look high

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Using CAPE Ratio to estimate global stock market valuations

The idea behind the CAPE ratio is that company earnings tend to be volatile and cyclical fluctuations have a huge impact on the traditional trailing 12-month P/E ratio. Instead of using annual earnings, CAPE ratio uses the average (inflation-adjusted) earnings of the last 10 years to smoothen out any regular cyclical variations.

Professor Shiller popularized the ratio when he demonstrated the clear historical relationship between the ratio and market returns when calculated for the S&P 500 index. Multiple studies have shown that Shiller PE can be successfully applied also to global markets.

For additional information about using CAPE on a global scale, check the writings by Meb Faber. Mr. Faber’s blog covers practically everything you need to know about the ratio.

Global stock market valuations in 2023

Based solely on the CAPE ratio, the most expensive stock markets (among the 25 largest economies measured by GDP) can be found from India, United States and Japan. The Indian stock market has been trading at high multiples for many years but the nation’s equities just refuse to correct but keep reaching for higher levels. The high CAPE ratio of Japan is explained by the strong performance of the country’s stock market during the recent years and strong earning of the Japanese stock market. The trailing P/E ratio of the country is still reasonable.

The most undervalued nations are Poland, Hong Kong, Russia and Turkey.

So should you sell all your U.S. stocks and buy Russian and Turkish equities instead?

At the moment, the CAPE ratio of Russia’s stock market is mostly theoretical as the country’s equity market is pretty much uninvestable for all but Russian citizens. The case of Russia is a good example of the limitations of just looking at valuation metrics when making investment decisions. Moscow’s stock market has always look cheap across all different valuation ratios and multiples but it has become painfully obvious to all Western investors that the Russian stocks have been cheap for a reason.

Turkey’s valuation multiples are currently clearly lower than they have been in the past but based on the political turmoil in the country the low valuation can easily be justified.

When we have calculated the CAPE ratios, we have also always included negative earnings. This is the reason why the ratio is so high for the Italian stock market. The companies part of the Italy’s benchmark index, FTSE MIB, posted negative total earnings for the fiscal year of 2011 and for the fiscal of 2013. The FTSE MIB companies were also barely profitable in 2020. If companies with negative earnings would be excluded from the calculations, the CAPE ratio for Italy would be much higher.

What matters more, valuations or market liquidity?

The theory behind the interplay of valuations and market liquidity (the availability of money) used to be that while changing liquidity can have a significant impact on short-term price movements and market stability, valuations will always determine the long-term performance of the stock market.

Over time, stock prices must align with the underlying fundamentals of companies. If valuations are too high relative to these fundamentals, a correction must always follow sooner or later. How could it be any other way?

But could it be possible that in the world of active centrals banks trapped between periods of quantitative easing and quantitative tightening that the availability of funding and money has become a key factor of determining stock prices also during the long term? Coud it be that the stock price of a company will significantly affect the behavior and risk taking of the company’s executive team and has a wide influence when it comes to the future growth and earnings of the company? Does the rise of passive investing make the comparison of current valuation multiples to historical levels a useless exercise?

We are in the middle of a great financial experiment by the governments and central banks around the world. Time will tell if the old rules of investing will still be true in the future.