CLSA on Thursday said the decoupling of domestic bonds and equity vis-a-vis global peers is unsustainable and is a reflection of lack of margin of safety.
In its latest strategy note, the foreign brokerage noted that the difference between 10-year Indian bond yields and US GSec (government securities) yields have narrowed to a 13-year low of 3.3 percentage points.
This has been seen at a time Indian equity valuation premium is at near-record against peer markets as well as to domestic bonds, indicating decoupling for Indian bonds as well as equity markets.
“We do not expect this to be sustainable and regard it as indicative of a very low margin of safety,” CLSA said in its largest strategy note.
CLSA said a simple valuation mean reversion anchored on bond yields indicates fears of 30 per cent downside in the Nifty!
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To be sure, the US 10-year bond yield has jumped 150 basis points in less than two months to about
4 per cent, an almost 14-year high. In comparison, CLSA said, the Indian 10-year government bond yield has risen only 25 basis points from its recent lows to 7.3 per cent.
CLSA said India is the only market other than the US where equity valuations are extended versus
domestic bonds. At about 2 percentage points, the difference between India’s 10-year GSec yield and
the Nifty’s earnings yield is at a point at, which negative equity returns usually ensue, it suggested.
“The Nifty’s absolute PE is slightly below +1SD of its historical average and at levels where positive equity returns are usually not forthcoming. At the 98-99th percentile, India’s relative valuation to EMs and Asia ex-Japan is also near record highs,” CLSA said.
A simple mean reversion could drive a deep pullback, CLSA warned.
