The Indian equity markets have been treading lower for the past couple of weeks, after touching a lifetime high on July 20. The BSE Sensex has closed in the red in seven of the past nine-trading sessions. According to a recent report by Business Standard, one of the factors driving down stock prices on Dalal Street is the shrinking spread between the earnings yield on Indian equities and the yield on 10-year US government bonds.
The spread between the Sensex earnings yield and the 10-year US government bond yield is now almost zero, against 0.34 percent at the end of December 2022 and 1.74 percent in July last year. The current spread is the narrowest in 187 months, said BS. It further stated that a zero or a negative spread was last seen in the last quarter of 2007 and early 2008, ahead of the big crash in stock prices in 2008.
The Sensex had an earnings yield of 4.01 percent on Wednesday, the same as the 10-year US government bond yield. This provides little or no financial incentive for foreign portfolio investors to put money in Indian equities, rather than risk-free US treasury bonds, said the market daily.
As per BS, the sharp decline in the spread is due to a decline in earnings yields in the Indian equity market, along with a rise in bond yields in the US. The Sensex earnings yield is down 20 basis points in the past 12 months from 4.31 percent at the end of August 2022. In the same period, the yield on 10-year US government bonds is up 92 basis points from 3.2 percent at the end of August 2022, it added.
The spread between the Sensex earnings yield and the 10-year US government bonds is crucial as the rally on Dalal Street is largely driven by inflow from foreign portfolio investors (FPIs). A sell-off by FPIs has also accompanied the current weakness in the equity markets, added the report.
This has made the Indian equity markets less attractive to foreign investors. “The equity valuation in India is nearly 50 percent higher than the average valuation of 26 global markets. This is now driving an underperformance of the Indian equity markets in an environment of hardening bond yields in the US,” said Dhananjay Sinha, head-research and equity strategy at Systematix Institutional Equity.