Are We Paying Tomorrow's Returns Today?

The Question

Markets rarely feel expensive while they are rising. Money is easy, the stories are good, and prices drift up quietly. So the question is: are investors buying real growth, or paying today for returns they would otherwise get tomorrow? If price says anything about the long run, expensive markets should lead to lower returns later. That is what the CAPE ratio tests.

What CAPE Measures

The Cyclically Adjusted Price-to-Earnings (CAPE) Ratio, or Shiller's PE, divides the market's price by its average inflation-adjusted earnings over the past 10 years. A decade smooths out booms and recessions, which make any single year's earnings misleading. A high CAPE means paying more for each rupee of long-run earnings. A low one means equities are cheap against what they have historically earned.

Where India Stood

The last month with full 10-year returns after it is February 2016. In January 2016, a month before, CAPE was about 19.1, around the 28th percentile of its range: cheaper than much of the past, but not the deep discount of a crisis. Indian valuations move in clear cycles: cheap when money is tight and investors are nervous, expensive when money is easy and optimism drives big rallies.