Forecast or Fallacy? Shiller's CAPE: Market and Style Factor Forward Returns in Indian Equities

Abstract

This paper explores the relationship between CAPE and future returns across a range of market benchmarks and long-only styles in the Indian equity market. We create and use a new Shiller CAPE series for India using indices that are publicly available. We find a statistically significant inverse relationship between CAPE values and forward returns across styles and periods, although CAPE may not strictly qualify as a market timing tool. In addition, there is a direct relationship between CAPE and drawdowns. These findings suggest that investors should adapt their expectations of investment returns based on CAPE value. We show that different size-and style-based indices have different reaction functions to the same starting value of CAPE with value and low volatility showing higher resilience. The study contributes to the evidence from the Indian market on the predictive power of valuations for future returns, improving our understanding of market dynamics.

Keywords: Shiller-PE, CAPE, Equity Market Returns, India JEL Classification Codes G00, G11, G12

JEL Classification: G00, G11, G12