Indian bond, equity markets decoupled; see 30% downside in Nifty50: CLSA

The decoupling of Indian equity markets, this year, from the global markets has been remarkable. While the S&P 500 has lost over 20 per cent in CY22 so far, the Nifty50 index is marginally in the red

Global research and broking house CLSA sees a 30 per cent downside in Nifty50 from the current levels, even as it believes that the Indian bonds and equity markets have decoupled from their global peers. 

“The difference between 10-year Indian and US G-Sec yields has fallen to a 13-year low of 3.3 percentage points (ppt). This, along with a near-record Indian equity valuation premium to peer markets as well as to domestic bonds, indicates a kind of decoupling for Indian bonds as well as equity markets,” wrote Vikash Kumar Jain of CLSA in a recent note.

However, this decoupling, Jain of CLSA said, is unsustainable and regard it as indicative of a very low margin of safety. India, according to CLSA, is the only market other than the US where equity valuations are extended versus domestic bonds. At about 2ppt, the difference between India’s 10-year G-Sec yield and the Nifty’s earnings yield is at a point at which, Jain believes, negative equity returns usually ensue.

“A simple mean reversion could drive a deep pullback: keeping US bond yields at 4 per cent, reverting to the 5-year average difference of 4.7ppt versus the Indian bond yield would take it to 8.7 per cent. The historical average difference of 1ppt versus earnings yield would take the Nifty’s fair earnings yield to 7.7 per cent, implying 13x price-earnings (PE), 30 per cent below the current 12-month forward PE of 18.3x. A simple valuation mean reversion anchored on bond yields indicates fears of 30 per cent downside in the Nifty,” Jain wrote.

Meanwhile, the decoupling of Indian equity markets, this year, from the global markets has been remarkable. While the S&P 500 has lost over 20 per cent in calendar year 2022 (CY22) so far, the Nifty50 index is only marginally in the red. 

This disparity in performance, according to experts at Julius Baer, was primarily on account of the strong domestic flows into Indian equities, at a time when foreign institutional investors (FIIs) were selling heavily. The bull-run of the past couple of years, they believe, created a positive wealth effect for domestic investors, and the positive sentiment continued through the first half of 2022, despite Ukraine, inflationary pressures, and US Fed and Reserve Bank of India (RBI) tightening their respective monetary policies to tame inflation.  

 

“Equity Mutual Funds and Portfolio Managers witnessed record flows in their schemes over the past couple of years. Besides, with low interest rates and unattractive fixed Income yields for a fairly long period, investors were incrementally more inclined to add equities in their portfolios,” said Unmesh Kulkarni, managing director and senior advisor at Julius Baer India.