Why Interest Rates Are Only One Part of a High CAPE
CAPE compares stock prices with a long average of inflation-adjusted earnings. It does not, by itself, tell you what interest rates, expected growth or uncertainty investors face. Those factors can change how a given earnings stream is valued.
In a simplified valuation model, a future dollar of earnings is worth less today when investors apply a higher discount rate. A lower real rate can support a higher present value, all else equal. But “all else equal” is a strong assumption: expected cash-flow growth and the risk attached to those cash flows can change at the same time.
Three inputs can move together
A Federal Reserve Bank of San Francisco analysis compares CAPE with a model that includes the natural real interest rate, potential-output growth and macroeconomic uncertainty. Its framework illustrates why interest rates are one part of a valuation explanation rather than a complete answer.
The CAPE and the COVID-19 Pandemic Effect working paper by Robert Shiller, Laurence Black and Farouk Jivraj also studies equity valuations relative to long-term interest rates and bonds. These are model-based comparisons; the choice of rate measure and assumptions affects the result. The FRED 10-year inflation-indexed Treasury series is one public measure of real yields, but it is not automatically interchangeable with every historical real-rate series used in valuation research.
What rate context can and cannot do
Adding rate context can help explain why two periods with similar CAPE readings may have different valuation assumptions. It does not prove that lower rates make any stock price reasonable, or that a market with a high CAPE must fall when yields rise.
Keep the comparison matched: identify whether the measure uses nominal or real rates, what maturity it uses, how expected inflation is estimated, and whether the earnings yield comes from trailing earnings or a long-run average. A spread can be informative while still depending on those choices.
For the earnings-side measurement debate, read CAPE-H explained. This article is part of CAPE, Accounting and Long-Term Stock Returns: A Plain-English Pillar Guide.