nifty: Wide earnings yield gap signals muted stock gains in near term

Mumbai: Has the stock market run up too fast, too soon? The gap between Nifty’s estimated earnings yield and the yield on a 10-year government bond is showing that the 10% rebound in the key indices might be excessive.

The spread between Nifty earnings yield vis-a-vis the 10-year GSec yield has widened the most since June 2018, suggesting the market upside could be capped in the near-term, said analysts.

“The gap between 10-year G-Sec and earnings yield has further widened and is relatively high, post the recent market rally, which may weigh on the stock market performance in the near-term,” said Kunal Vora, head of India equity research,

. “Historically, at this gap level, market returns in the next one year have been muted. Assuming that bond yields remain in the same range, earnings yield has to increase to narrow down the gap possibly through a time correction or a market decline.”

The difference in yield between Nifty earnings and government bonds is tracked to find whether the risk-reward ratio to invest in equities is favourable.

The Nifty has rallied 10% in the past month from the 2022 lows, while the bond yield has declined 23 basis points from 7.37% to 7.16% during this period. Estimated earnings yield to bond yield is trading below its 15-year average of 0.76%.

The current equity market yield is around 4.57% – slightly lower than the 10-year average of 4.8%. The valuation multiples appear expensive even on an absolute basis, and therefore the possibility of consolidation appears more likely in the near term, said analysts.

“The gap in valuations between Nifty and MSCI Emerging Markets index, as well as the gap between the earnings yield of Nifty and the 10-year G-Sec yield, are adverse factors, and we can expect market returns to be more muted in the near term,” said S Hariharan, head- sales trading, .

Foreign portfolio investors have net sold nearly ₹17,013 crore in Indian debt instruments so far this year, while they have pulled ₹2 lakh crore out of equities. In July, they turned net buyers to the tune of ₹6,720 crore for the first time in 10 months.

“Despite the ‘easing of nerves’ on interest rates, we believe we are still in a quantitative tightening cycle, hence it is less likely that equity valuations will yield less than 5% or trade above 20x on a 1-year forward basis as against current valuation of 19.2x,” said Vinod Karki, equity strategist,

. “The rising geopolitical tensions between the US and China bring more uncertainty for capital markets.”

Earnings yields are the inverse of the price-to-earnings ratio. If the company has an earnings yield of 5%, it means the stock has a PE ratio of 20 times.