Learning objectives
By the end you can:
- Construct a cyclically adjusted price-to-earnings ratio for either market from ten years of index earnings and a stated inflation series, and state the reading against its own history as a percentile rather than as an adjective.
- Quantify the three standard objections to that ratio: the inflation adjustment being skipped, a single write-off year distorting the ten-year mean, and net buybacks inflating a per-share series relative to aggregate earnings.
- Read a valuation-to-return relationship honestly, converting a fitted slope, a coefficient of determination and a residual standard deviation into a prediction band, and stating the effective sample size once overlapping windows are accounted for.
- Compute a market capitalisation to gross domestic product ratio for both markets and repair its denominator, using the listed sector's share of value added in India and the foreign-revenue share of the index in the United States.
- Separate a genuine multiple re-rating from a composition change, computing the index multiple as a market-value-weighted harmonic mean and showing the shift when sector weights move but no sector's own multiple does.
- Demonstrate arithmetically that the Fed model is an inflation-illusion error, computing the earnings-yield spread against a nominal yield and against an exact real yield in a high-inflation and a low-inflation year, and showing that the ranking between the two years reverses.
- Solve for the implied equity risk premium at index level using a two-stage cash-flow model with dividends plus net buybacks, and report its sensitivity to the terminal-growth convention and to the stage-one growth assumption.
- Assemble a five-gauge market-temperature dashboard with each gauge's reading, its own-history percentile and a written licence statement, and resolve a disagreement between an absolute gauge and a relative one.
- Operate a defensive allocation band with a floor and a ceiling, running a stated multi-year path, showing every rebalancing trade, and computing what the discipline costs in a bull market and saves in a drawdown.
- Compare a systematic investment plan against a lump sum on a rising and a falling price path, computing the average cost as a harmonic mean and stating why the comparison is usually the wrong one for a salaried investor.
- Derive the index default from arithmetic rather than belief: the zero-sum identity after costs, the fee-drag identity, the horizon effect on the share of active funds that beat, and the survivorship and backfill corrections to any fund database.
- Size an active sleeve against an indexed core, computing the gross alpha the sleeve must earn to justify itself and writing the sentence that decides which capital is allowed into it.
- Write a one-page investment policy with an allocation band, a rebalancing trigger, an enough number, a named edge for any active capital, and a review cadence you can follow inside a drawdown.
Prerequisites & connections
Builds on. M3.02 gave you the equity risk premium three ways, and the implied route computed here is that machinery pointed at an index rather than at a single company; the historical-versus-implied argument, the country-risk stack and the Damodaran two-stage iteration all belong there and are used, not rebuilt. M3.06 gave you multiples and the discipline that a numerator and a denominator must claim the same cash, which is what makes an index earnings yield comparable to a bond yield only after the bond yield has been made real. M7.05 gave you the cycle and the Kindleberger anatomy of a bubble, so you already know how a market gets to a high multiple and what the late stages look like from the inside. M9.02 gave you portfolio construction, the concentration case, the factor menu and the active-versus-passive debate. M0.03 gave you the fee-drag identity, which reappears here as the quiet arithmetic that beats every market call in the file.
Feeds forward. E11.06 (Event-Driven Special Situations and the Canon's Unclosed Drills) is the natural destination for any capital that survives the named-edge test set out below. Its section on the performance derby is the structural mirror of the index-default argument here. The same relative-return mandates and quarterly reporting that make indexing the right default for you are what leave event-driven mispricings on the table for someone else. M9.04's process capstone consumes the policy you write in the mini-project. M10.04's lifelong-practice audit is where the review cadence you set here gets its first genuine test. The dashboard row set built in section 4.8 is the valuation block of the program's macro dashboard artefact, and the two are meant to be maintained together.