Losing sheen: Equity valuations fall amid spike in US bond yields

Price-to-earnings expand when yields soften and the valuations come down when yields harden as risk-reward dynamics change

As investors flee risky assets, equity valuations have come off sharply this year. The MSCI Emerging Market (EM) currently trades at less than 11 times its projected one-year forward earnings. Valuations for the EM index have come down by 14 per cent this year. Similarly, the valuation for MSCI ACWI (All Country World Index) is down 12 per cent to 14.3 times.  In comparison, the de-rating for Indian equities has been relatively less. 

The MSCI India index currently trades at 17.6 times its one-year forward earnings, down around six per cent from where it was during the start of the year. Analysts say, equity markets are getting re-priced to factor in the rise in US Treasury yields. Historically, there has been a negative correlation between US bond yield and the price-to-earnings (P/E) multiple for equity markets.  

In other words, P/E expands when yields soften and the valuations come down when yields harden as risk-reward dynamics change. Since the start of the year, the yield on the US Treasury has risen by around 80 basis points from 2.4 per cent to 3.2 per cent. 

As the yields are expected to rise further as the US Federal Reserve is expected to hike interest rates further to rein in inflation. PE valuations for India particularly are still above their long-term average of about 16 times. Experts say, the Indian markets could correct further if there is no meaningful pick up in earnings and globally bond yields continue to rise.