Five charts that should worry Indian equity investors in 2018

1. India among three most expensive markets in the world

The Calm Investor | India Market Valuations


“Between 1979 and 2015 we observed an average Shiller-CAPE of 18.3 and an average price-to-book (PB) of 1.8 in 17 MSCI country indices. Based on the assumption that these average valuation levels approximately represent a fair valuation level, Southern Europe, and Emerging Markets are attractive whereas the US stock market significantly trades above its fair value.”

The United States, Switzerland, and India stand out as the most expensive markets in the world at the moment when considered on Shiller CAPE (Cyclically Adjusted Price-Earnings) and Price-Book metrics. However, my analysis of historical returns showed only a weak linkage between Price-Book and future returns, the caveat being my analysis considered annual returns only.

2. CAPE and PB forecasts suggest subdued returns over next decade

The Calm Investor | India 2018 Returns


“By 06/30/2017, the US stock market’s CAPE and PB are 28.0 and 3.1, respectively. During the last 130 years, comparable valuations only led to below-average annual returns of 3.5% for the following 10-15 years. With a CAPE of 19.4 and PB of 1.8, German stocks promise considerably higher returns. The highest long-term returns can be expected for the Emerging Markets.”

India’s projected returns over the next 10-15 years are only 5% annually, compared to 14.5% for Russia, 9.8% for China and 9.4% for Brazil.

3. India CAPE-predicted long-term returns between 2.5% and 7.5%

The Calm Investor | India Returns Distribution


“The current US Shiller-CAPE of 30.3 was followed by average long-term returns between 0.8% and 4.6% on average in the past. Though, the range was huge so that long-term returns of -4.1% and 10.7% were seen. Attractive valuations in Russia and Brazil promise higher performances; historically, such valuations have never been followed by negative long-term returns.”

Range of forecast returns for India between 2.5% and 7.5% annually. The simplistic model I used suggests 2018 returns between marginally negative to a deep correction.

4. Current India CAPE levels suggest 20%+ drawdown in three years

Source: Predicting stock market returns using Schiller-CAPE | Starcapital Research

India CAPE is currently in the 25-30 range implying a deep correction. Note that this is drawdown predicted over three and ten years which means it could be a sudden fall or a long downward grind. Which do you prefer?

5. But India performed better than predicted in 2017, is much more expensive in 2018

The Calm Investor | 2018 Expected Returns


“Based on the December 2016 valuation ratios, the 15 most attractive countries based on CAPE led to a mean return of 24%. The highest growth rates were seen in China (+52%), Turkey (+49%) and Hong Kong (+35%). With an average return of 16%, the return of the 15 most expensive countries were considerably lower. Will this trend continue in 2018?”

India CAPE was 17.6 at the end of 2016 and outperformed the suggested returns predicted by the model. India CAPE currently is at 23.1, detractors of the model could say it could well continue to go against the model.

There are several criticisms of the Shiller-CAPE ratio as a strong predictor of market performance, key being the limited comparability of the CAPE ratio across markets with very different index compositions.

In spite of its weaknesses, there is merit in considering the possibility of a sharp correction in the near future.

Further Reading:

Brace for negative returns in 2018 – Calm Investor

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