Good news for market bulls: market bears’ favourite valuation measure is fatally flawed. Bad news for market bulls: stocks have rarely been so expensive.For decades, Nobel laureate Robert Shiller’s cyclically adjusted price/earnings ratio (Cape) has been the market’s perennial pessimist. Cape, which smooths profits over a decade, has long indicated that US stocks were dangerously expensive, but investors who ignored those warnings were rewarded as indices marched higher.A paper by Federal Reserve Board economist Dino Palazzo, The Cape That Cried Wolf, suggests Cape really was exaggerating the danger.Palazzo says accounting rules made modern companies, which invest heavily in research and development, look less profitable than they were. Unlike spending on factories or machinery, research and development (R&D) spending is treated as an immediate expense rather than a long-term asset. That depresses reported profits, and it makes valuations seem artificially high.How high? Since 1992, Cape has overstated how expensive the market is by an average of 44 per cent, he says.https://www.irishtimes.com/your-money/2026/07/27/andy-burnham-and-the-uk-stock-market-panic-that-wasnt/[ Andy Burnham and the UK stock market panic that wasn’tOpens in new window ]His solution is Cape-H, a historically comparable version of the ratio that adjusts for accounting distortions. Recalculate history using Cape-H and many false alarms vanish. During the 2010s, for example, Cape was screaming danger, but the adjusted measure shows stocks were trading at moderate valuations. No wonder stocks didn’t crash.Now for the bad news: Cape-H now tells much the same story as the original measure, with US stocks trading close to the most expensive levels in history.This doesn’t mean a crash is imminent, because valuations don’t help with timing. However, they do suggest markets are more vulnerable and have less room for error when shocks arrive, and that returns over the next five years will be lower than normal.It seems the valuation warning rightfully ignored for years may finally deserve investors’ attention.