'Higher bond yields are making the equity market more earnings sensitive'

Fed expected to hike rate and RBI's recent minutes suggesting a likely start to rate hike cycle, could pave the way for yields to increase, said Elara Securities.

Large-caps have underperformed their smaller peers thus far in 2026. Harendra Kumar, MD & CEO of Elara Securities, told Heena Ojha in an email interview that they prefer large-caps at the current juncture given the valuation comfort and downside protection. "We would become more aggressive on large-caps if crude, yields or rupee stress intensifies," he added. Edited excerpts:

 

How are rising bond yields changing the outlook for equities and investor positioning?

 

Higher yields are making the equity market more earnings-sensitive and less valuation-sensitive. India’s 10-year government bond yield ended last week at 6.96 per cent as domestic liquidity improved and concerns on the credit-to-deposit ratio are easing. However, with the Fed expected to hike and RBI’s recent minutes suggesting a likely start to rate hike cycle, we believe that yields are likely to increase.

 

 

The transmission works through two channels. First, a higher risk-free rate raises the discount rate and equity hurdle rate, making long-duration stocks and businesses dependent on price-to-equity expansion more vulnerable. Second, higher US yields increase the return available on dollar assets, compress India-US yield spreads and can make foreign investors more cautious on emerging-market allocations.

 

Portfolio positioning should therefore favour earnings visibility, cash generation and balance-sheet strength. In a higher-yield environment, returns are less likely to come from broad multiple expansion; earnings growth will need to do more of the work.

 

What's your assessment of how crude oil prices will play out going ahead? Are earnings estimates pricing this in?

 

Due to the see-saw nature of the geopolitical landscape, crude continues to be a material near-term risk. Brent averaged around $88/bbl in August but has climbed to almost $97/bbl following renewed disruption around the Strait of Hormuz. But India's buffers are considerably stronger than in earlier oil shocks. RBI measures have now mobilised $136.38 billion of foreign-currency inflows, while FX reserves reached a record $740.8 billion as of 28 August 2026. These buffers improve the RBI's ability to manage disorderly currency moves, but they do not remove the earnings impact of expensive oil.

 

 When should investors turn more aggressive on large caps, and are SMID valuations stretched?

 

Large-caps are already more attractive on relative valuation. At end-August, the Nifty 50 was at 18.1x 12-month forward earnings, about 4 per cent below its 10-year average. In contrast, the Midcap 100 was at 28.1x, while the Smallcap 100 at 23.2x trading well above its respective averages.

 

But valuation is only one part of the argument. In Q1FY27, ex-Energy PAT grew 14.1 per cent, 16 per cent and 15.9 per cent across large, mid-and small-caps, respectively, with mid-caps showing the cleanest sales-to-profit conversion. Mid-cap ROE has also recovered to 13.5 per cent, only 150 basis points below the Nifty 50, while our coverage SMID profit share is expected to rise from 19.6 per cent to 21.4 per cent by FY28E.

 

Our preference is therefore large-caps for valuation comfort and downside protection, combined with selective SMIDs. We would become more aggressive on large-caps if crude, yields or rupee stress intensifies.

 

Is IPO demand shifting structurally towards QIBs as retail participation moderates?

 

In the first half of 2026, the QIB category was subscribed an average 48.4 times, compared with 12.8x for retail; NII/HNI demand was even stronger at 63.1 times. The structural change is the growing depth of domestic institutional capital and its ability to absorb increasingly large issuances. That makes institutions a more important anchor for deal execution and price discovery. Retail participation, however, is more cyclical. It is highly sensitive to secondary-market volatility, IPO pricing and the prospect of listing gains.

 

Do you expect the US Fed and the Reserve Bank of India (RBI) to hike rates this year? What could trigger or delay hikes?

 

For the Fed, a hike this year has become a meaningful probability amid sticky inflation and growth stickiness. The recent commentary by the Fed Chair suggests that a rate hike may be inevitable, although the timing is still a debate. US August payrolls increased 162,000, well above the Reuters consensus of 56,000, while unemployment remained at 4.1 per cent. Following the release, futures markets priced roughly a 57-59 per cent probability of a September hike. Fed Chair Kevin Warsh has also stressed that inflation remains above the 2 per cent target and that price stability should currently be the Fed's predominant focus.

 

For the RBI, the repo rate remains 5.25 per cent. April - June 2027 quarter (Q1-FY27) GDP growth was 7.8 per cent, while the RBI projects CPI inflation at 5.9 per cent in Q3FY27. The recent minutes of the RBI amid a robust GDP print suggest that the next action from the RBI’s MPC will likely be a hike. The timing, however, is likely to be contingent on the Fed’s action.

 

Which sectors could see the biggest rotation over the next year, and why?

 

Over the next 12 months, the biggest rotation could be towards financials, auto (especially 2 wheelers and auto ancs), consumer durables, and select industrials & capital goods as the domestic and global capex cycle takes hold and a surge in domestic liquidity aids credit growth.

 

We believe the falling intensity of depreciation is in sync with lower perceived macro risk, i.e. these sectors have generated the strongest relative performance when the intensity of rupee depreciation eases. The Q1FY27 earnings backdrop supports this potential rotation.

 

Notwithstanding the recent resurgence of US-Iran conflict, we believe the domestic economy has been very well insulated amid surge in FCNR(B) inflows.