Each point represents a starting month in S&P 500 history. The X-axis shows the trailing P/E ratio at that moment; the Y-axis shows the actual annualized total return earned over the following 10 years. The negative correlation is the central thesis: the more you overpay, the less you earn. Source: Robert Shiller (Yale) · 1881–2014.
J.P. Morgan's Guide to the Markets showed that historically, buying the S&P 500 at a P/E above 23× produced 10-year annualized returns between −2% and +2% — in every single case, with no exceptions. Meanwhile the long-run average is ~10%/yr. The annual return is almost never between 8% and 12% in any given year — but the 10-year compounded average clusters tightly around that figure when you buy at fair value (P/E 12–18).
The Cyclically Adjusted P/E (CAPE) divides the current index price by the average inflation-adjusted earnings of the past 10 years. This smooths out the wild swings in annual earnings (recessions, one-off items) to give a cleaner picture of structural valuation. A regular trailing P/E uses only the last 12 months of earnings — easily distorted by a single bad or good year.
For each month M from 1881 to 2014: record the CAPE at M, then compute the annualized total return (price appreciation + dividends reinvested) from M to M+120 months (10 years). Each dot is one such pair. Points after 2014 are excluded because the 10-year forward window has not yet fully elapsed.
A correlation of −0.76 is extraordinarily strong for macroeconomic data. Valuation at purchase is the single most reliable predictor of long-horizon returns available to investors — far more reliable than GDP forecasts, earnings growth estimates, or analyst price targets. You can't control returns. You can control the price you pay.
Robert Shiller (Yale University) · Irrational Exuberance dataset, updated monthly. Freely available at econ.yale.edu/~shiller/data.htm. The dataset covers S&P 500 (and predecessor indexes) monthly price, dividend, earnings, and CPI from January 1871 to present. This page uses data through 2014 for complete 10-year forward windows.