Bond yield ratio shows India’s still attractive on relative valuation

Bond yield ratio shows India’s still attractive on relative valuation

ET Intelligence Group: Is India overvalued and overbought? Or, should a special dispensation be made, considering the once-in-a-century pandemic and abundant global liquidity?

Amid overwhelming consensus to not bet against the Fed, the accent is on relative valuation. India scores better compared with its EM counterparts on the relative valuation matrix. As a result, Asia’s third-largest economy has received record inflows in the last three months.

The global equity valuation matrix has re-based with bond yields staying at the record low level and inflation to remain low for an extended period of time. The spread between bond yield and earnings yield — the inverse of the price-earnings multiple — is 143 basis points, which is quite close to the historical average level of 112 basis points. Thus, equities still remain relatively attractive to bonds.

Equities more attractive than bonds

Typically, spreads above 200 basis points trigger buying. The 10-year bond yield eased 68 basis points last year. Jefferies believes that India’s valuations are still manageable due to the favourable bond yield-earnings yield matrix and believes that low yields are likely to stay. The pressure on global yields can be gauged from the fact that nearly $18 trillion of debt is trading below zero yield and this amount has doubled since 2019.

Relative valuation of India has been trading close to historical averages thanks to the rally in the entire EM universe in 2020 due to declining dollar and LIBOR. The momentum could stretch, but the success of the vaccination programme is key.

Nifty 50 is trading at a 41 per cent premium to the EM index compared with its 10-year average of 39 per cent. The net short bets by the traders linked to the Dollar index rose to the highest level in almost a decade, according to CFTC data. The superior price-earning growth (PEG) ratio of India compared with the EM index may support (or even expand) India’s valuation.

In 2020, the entire world’s market capitalisation soared to a record level as investors lapped up equities in chase for yield. This resulted in global market capitalisation touching $100 trillion for the first time.

However, India’s contribution to the global market capitalisation is still hovering at the historical average level of 2.38 per cent. This ratio was higher than 3 per cent in 2008, 2010 and 2018, when India reached an overheated zone.

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