Market mayhem: India earnings yields now trading higher than US bonds

A sharp rise in yield spread is a bullish signal for Indian equity but it has been overshadowed by the negative cues in the global markets, said analysts

Following the recent correction, the Indian equity market is now trading at a discount compared to the yield on the benchmark US 10-year government bond. The benchmark S&P BSE Sensex is currently trading at an earnings yield of 4.3 per cent, nearly 58 basis points higher than the yield on the US 10-year Treasury bond, which has dropped to 3.72 per cent, its lowest in 15 months.

For nearly a year beginning September last year, the Sensex earnings yield was lower than the US benchmark bond yield. The yield spread was minus 0.31 per cent at the end of June this year and had touched a low of minus 0.5 per cent at the end of April this year. According to analysts, the sharp rise in the yield spread is a bullish signal for Indian equity, but it has been overshadowed by negative cues in the global markets. This rise in the yield spread of Indian equities over the US risk-free rate is due to a decline in equity valuations and a simultaneous drop in US bond yields.

The Sensex’s trailing price-to-earnings (P/E) multiple fell to 23.2x on Monday, compared to 24.2x at the end of July and a 52-week high of 25.2x at the end of March this year. This current valuation is the lowest since October last year when it had dropped to 22.35x.
 

The earnings yield is the inverse of the stock P/E multiple; thus, a lower earnings multiple results in a higher earnings yield, and vice versa. The decline in US bond yields has been even more pronounced. The yield on US 10-year Tre­asury bonds has slumped to 3.72 per cent from 4.5 per cent at the end of June this year. The current bond yields in the US are the lowest in 15 months.

A positive spread between Indian equity yield and US long-term Treasury bonds makes investing in Indian equities attractive for foreign investors and should lead to fresh buying by foreign portfolio investors (FPIs), potentially driving a recovery in stock prices. However, analysts are sceptical that the sudden rise in the yield spread will trigger fresh inflows from FPIs, given the uncertainty in global markets.
 

“The rally in equities is largely driven by three factors: corporate earnings, the risk-free rate (or yield on sovereign bonds), and market premium (or volatility index/Vix). Currently, only one factor — the risk-free rate or yield spread — is in positive territory, while the other two factors are in the bearish zone. We need at least two factors to be in positive territory to fuel a rally in stock prices,” says Dhananjay Sinha, co-head of research and equity strategy at Systematix Institutional Equities.

The Chicago Board Options Exchange Vix, the global benchmark for market risk premium, skyrocketed to 61.7 on Monday from 23.6 on Friday and 12.4 a month ago. Most of this rise in the Vix occurred in the last four trading sessions, compared to a level of 16.4 at the end of July.

Similarly, the India Vix surged 58 per cent in the last two trading sessions, closing at 20.43 on Monday compared to 12.93 on Thursday.

Corporate earnings in India are also not supporting the equity markets. The combined net profit of 488 companies that have declared their quarterly results so far is down 1.6 per cent year-on-year (Y-o-Y) in the first quarter (Q1) of 2024-25 (FY25), marking the first contraction in earnings in the past seven quarters.

Non-banking, financial services and insurance companies performed worse, with their combined net profit down 9.6 per cent Y-o-Y in Q1. The earnings outlook for FY25 remains muted, given single-digit revenue growth over the past five quarters and margin headwinds across sectors. Positively, a good monsoon could somewhat boost demand.

The current level of the yield spread is still a third of what foreign investors have historically enjoyed on average. The yield spread has averaged 1.88 per cent over the past 10 years, with a median value of 1.83 per cent. Given this, foreign investors may wait before increasing their investments in Indian equity.

“It’s only a matter of time before the Indian equity market starts rallying once again, driven by largecap stocks and fresh inflows from FPIs," says Chokkalingam G, founder and chief executive officer of Equinomics Research (formerly Equinomics Research and Advisory).