Shiller's CAPE and Forward Real Returns in India

Abstract

We show an inverse relationship between elevated valuations (high CAPE) and forward real-returns over 1, 3, 5, and 10 years in India, similar to other international studies. There is a reasonable probability (38%) that 1-year returns are negative when CAPE is in its highest quintile. While “time in the market” reduces the chance of negative forward real-returns, these returns are still lower than entering at lower quintiles of CAPE. Even in the longer term, forward real-returns have significant variability. Thus, CAPE on its own has limited use for market timing. However, the inverse relationship implies investors should lower their forward real return expectations and consider longer investment time horizons when starting CAPE is high without sound economic rationale.

Keywords: Shiller-PE, cyclically adjusted PE, equity market returns, India

JEL Classification: G00, G11, G12