Rising bond yields make largecaps attractive; mid, smallcaps may lag

Nifty 50's equity risk premium looks attractive

Largecap stocks are turning relatively attractive as bond yields climb. The same, however, is not true of midcap stocks and, especially, smallcap stocks, where price-to-earnings (P/E) multiples remain high. 

Largecap stocks are quietly telling Indian investors something by looking at the bond market. As 10-year bond yields touched 7 per cent intraday on Wednesday before closing at 6.9739 per cent, investors in the Indian markets were a worried lot, especially at a time when the Nifty 50 has returned -3 per cent over the past year and oil prices are rising. 

But data going back to 2012 shows that the equity risk premium — the gap between what stocks earn and what a 10-year government bond pays — for the Nifty 50 is at its best level in a long time. Even as benchmark yields have climbed through the year and earnings yields are at 4.61 per cent, the Nifty 50 is looking attractive. 

Weekly data going back to 2012 shows that the equity risk premium for the Nifty 50 is at a comfortable level compared with the past 14 years. At -2.41 per cent, the equity risk premium is in the 66th percentile. Simply put, the gap between earnings yields and bond yields was wider than it is now in 66 per cent of the weeks since 2012. The corresponding figures for the Nifty Midcap 100 and the Smallcap index are -3.85 per cent (26th percentile) and -3.61 per cent (32nd percentile), respectively. 

While the largecap segment looks attractive on a historical basis, midcaps and smallcaps are expensive. At P/E multiples of 31x and 33x, respectively, these segments are among the most expensive they have been over the past 14 years. Their risk premiums are in the bottom quartile of the past 14 years, a hangover from the 2023-24 rally that regulators themselves flagged as frothy. This makes for an interesting market that could move in two directions: a value-buy opportunity in the largecap segment, which represents blue-chip India and has been battered by two years of foreign outflows; and smallcaps now facing pressure from the bond market. 

The high cost of funds is likely to affect the smallcap segment at every level, from raising money to raw material costs. “Stock market returns for 2026-27 (FY27) are expected to improve. First-quarter (April-June/Q1) FY27 gross domestic product numbers and Q1 corporate results indicate improving prospects. Nifty 50 earnings for FY27 have the potential to grow by 12-15 per cent. The broader market has the potential to deliver above 15 per cent earnings growth. Investors — foreign institutional and domestic — can be optimistic about equity investment going forward. As a measure of abundant caution, investors may opt for a multi-asset strategy,” says V K Vijayakumar, chief investment strategist, Geojit Investments.