Equity market valuation rises as US bond yields ease

The Indian equity market valuation has been moving in tandem with the US 10-year treasury yield.

While the benchmark US bond yield has witnessed a nearly 70 basis point decline since the end of October this year, dropping from 4.93 per cent to 4.23 per cent on Friday, the Sensex earnings yield has slipped by nearly 45 basis points — from 4.5 per cent to 4.05 per cent.

Previously, Indian equities’ earnings yields rose in sync with the US bond yields.

The Sensex earnings yield climbed by 46 basis points between July and September, shadowing the 96 basis point rise in the US 10-year bond yield.

Earnings yield, the inverse of a security’s price-to-earnings (P/E) multiple, is the potential dividend for an investor if the stock pays out all its annual profits.

A higher earnings yield means a lower P/E multiple and vice versa.

The benchmark index trailing 12-month P/E multiple ballooned to 24.72x on Friday (December 8), from 23.72s at November’s end and 22.3x at October’s end.

The index trailing earnings per share dipped slightly from Rs 2,858 at the end of October to Rs 2,425 on Friday, meaning the index gains came solely from a rise in valuation.

“There’s been a sharp decline in US bond yields in recent weeks as investors believe inflation will moderate and the US Federal Reserve won’t hike rates.

"This sentiment is bolstered by falling crude oil prices and a sharp fall in the volatility index,” said Dhananjay Sinha, co-head of equities and head of Research of Strategy and Economics at Systematix Group.

This, he said, has sparked a global risk-on rally in equities that has now spread to India, fuelled by fresh buying by FPIs.

The market sentiment in India was also buoyed by the Bharatiya Janata Party’s (BJP’s) victory in three of four state Assembly elections.

The Chicago Board Options Exchange (CBOE) Volatility Index has sunk 42 per cent since the end of October this year, closing at 12.31 on Friday — its lowest level since November 2019.

In India, the Nifty Volatility Index (VIX) is down 7 per cent in the past three trading sessions after the index rose in the last week of November and early December.

Historically, a lower VIX has translated into higher stock prices.

Foreign portfolio investors (FPIs) have made fresh net investments worth $4.26 billion in November and December, after being net sellers in September and October.

According to National Securities Depository (NSDL) data, FPIs had cumulatively withdrawn $4.73 billion from the Indian equity market during September and October.

The net investment by FPIs in Indian equities is closely tied to the movement in US bond yields.

FPIs turn net buyers when US bond yields decline or stay low, and become net sellers when US bond yields rise or stay high.

For instance, FPIs sold off Indian equities worth $28.4 billion between January and June 2022 when the yield on 10-year US treasury bonds climbed from 1.78 per cent to 3.01 per cent.

They were also net sellers in September and October this year as US bond yields rose from 4 per cent to around 5 per cent.

In contrast, FPIs were net buyers from March to August this year as US bond yields softened and seemed to stabilise at around 4 per cent.

“Historically, strong FPI inflows have been associated with the markets making new highs,” wrote Amnish Agarwal of Prabhudas Lilladher in his recent India strategy report.

Analysts at Motilal Oswal Financial Services in their latest India Strategy report said: “Most global markets rallied in November with Brazil leading the pack.

"Market volatility in India and the United States is near three-year lows and FPI flows have turned positive after three months.”

According to the brokerage, the market sentiment has been boosted by buoyant inflow from domestic institutional investors, such as mutual funds, and a decline in key commodity prices that are at a two-year low, which should aid corporate margins in the forthcoming quarters.