The spread between bond yield and earnings yield has widened to the highest level since February, suggesting that the bond is becoming more attractive to investors, which normally accompanies with fewer risks.
A sharp rally in domestic stocks has taken the valuation of Nifty50 to 18.7 times of its one-year forward earnings, which is nearly one standard deviation above its long-term average. The benchmark index has surged as much as 15 percent from its March lows whereas the yields on the 10-year benchmark bond surged as much as 18 basis points over the last two months.
While India’s equity valuations versus bonds are still shy of the warning level, our proprietary India Bull-Bear Investor Sentiment Index is now at a 20-month-high 96% bullish reading, observed CLSA in an investor note. The foreign brokerage which has a cautious view on Indian stocks said, “The difference between India’s 10-year yield and 12-month forward consensus earnings yield has risen to 1.7ppts — still below the danger zone of 2.0ppts.”
The brokerage further added that the equity valuations versus debt are much more extended in developed markets like the US, France and the UK.
The measure which shows relative attractiveness of bond over equities has hit 287 basis points (bps) on Thursday, marking the widest gap Since February 1, data sourced from Bloomberg showed.
On the other hand, the yields on 10-year benchmark bond rose four basis points on Thursday to hit a two-and-a-half month high, tracking a sharp spike in US treasury yields after minutes of latest FOMC meeting hinted another rate hike this month. The rise in bond yield along with a fall in earnings yield resulted a widening gap between the two.
Analysts at Goldman Sachs expect moderate returns from Indian equities as it “over-delivered” in Q2 relative to the changes in the macroeconomic environment, suggesting consolidation of gains in the near-term. The foreign brokerage which expects a better performance in Q4 said, “History suggests modest forward returns from current starting level of valuations.”
(Edited by : Pradeep John)
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