Bond, corporate earnings yield spread still in 'overvalued' territory

The 10-year government bond yield, considered to be a risk-free instrument, have softened from 8.18% a month ago to 7.81 amid a decline in crude oil prices

The spread between government bond yield and Nifty earnings yield has narrowed to 325 basis points (bps) from nearly 400 bps in September. Analysts say the spread, however, remains in “overvalued” territory—anything above 300 bps.

The 10-year government bond yield, considered to be a risk-free instrument, have softened from 8.18 per cent a month ago to 7.81 amid a decline in crude oil prices. Meanwhile, Nifty earnings yield —which is earnings per share divided by share price—has improved to 4.6 per cent from 4.1 per cent in September following the correction.

The spread between bond yield and earnings yield decides the attractiveness of investing in equities—narrower the spread the better is the risk-reward for equity investors.

"Despite the recent correction in equity markets resulting in a narrowing of spreads, the spread between Indian government bond yields and corporate earnings yield continues to remain wide, which continues to point overvaluations in the markets," says a note by Ambit.

The average spread in the past seven years has been around 260 basis points.

“India’s overall market valuations are still on the higher side relative to history and bond yields,” says another note by Kotak Securities.