For the moment, investors could breathe relatively easy. Going by recent history, yields must harden more before equities in Mumbai are repriced. More importantly, if yields in New York or London head north when accompanied by growth, the mood in Mumbai isn’t circumspect — not in the long run.
Equity peaks have historically been preceded by a 130-basis point rise in yields on an average from the trough. From the recent trough, yields climbed 80 basis points, according to Credit Suisse.
During the 2008 global financial crisis (GFC), bond yields rose nearly 170 basis points before the market peaked.
The equity market would keenly watch the bottoming out of the treasury inflation-protected security (TIPS) as the real bond yields continued to fall despite inflationary expectations.
The US 10-year TIPS yield was negative 0.74 per cent on February 26 and broke the 200-day moving average (DMA) level. The correlation between TIPS and PE multiple expansion of stocks is very high. Interestingly, the one-month correlation between bond yields and the US equity market is breaking down.
Furthermore, emerging markets that have traditionally shown a negative impact of rising yields following the increase in borrowing costs could be better placed now because of the current account surplus at a 15-year high.
Back home, the spread between bond yield and earnings yield — the inverse of the price-earnings multiple — is currently at 150 basis points compared with the long-term average of 97 basis points, according to Bloomberg. In the previous 15 years, the Nifty 50 delivered positive performances on four out of five occasions when bond yields bottomed out, but underperformed the emerging markets, according to Jefferies.
When yields rose due to growth recovery, Nifty returns remained positive in both instances.