Spike in bond yields unlikely to take the sheen off equities
In the hindsight, the tone of global central bankers seems to remain dovish despite rise in bond yields as economy still needs support to sustain momentum in economic activities
A sharp rise in 10-Year US treasury yield in recent weeks (over 60bps spike in 2021 so far) acted as a speed-breaker of markets’ rally for global equities and weighed on investors’ sentiments. Given the mammoth size of global bond markets approximately over US$120trillion, which is ~1.5x of market value of global equities, any change in bond yields essentially results in sizeable impact on return of investors. Notably, soft monetary policy stance of global central bankers and deflationary scenario in the backdrop of demand disruption during pandemic kept bond yields abysmally low in 2020.
However, as fresh daily Covid-19 cases have started waning and progress of vaccine rollout is quite satisfactory in the US, prospects of faster economic recovery have become more imminent, which also got accentuated with the passage of huge US$1.9trillion fiscal stimulus in the US. Hence, demand scenario is expected to witness a strong boost with faster rebound in economic activities, which can potentially tend to stoke inflation. Therefore, the recent hardening in bond yields is the reflection of bond markets discounting increased prospects of faster economic recovery and possible increase in inflation. We understand a sharp rise in equity risk premium (led by dismal risk free govt’s bond rate) was a prime factor for premium valuations of equity markets in recent periods. Hence, reversal of bond yield essentially raises concerns about the sustainability of premium valuations of equities.
In the hindsight, the tone of global central bankers seems to remain dovish despite rise in bond yields as economy still needs support to sustain momentum in economic activities. Hence, a situation like taper tantrum in 2013 does not look to be in the sight in 2021.
While a modest spike in inflation can not be ruled out in a growth phase of the economy, an ease of supply disruption can check a sharp spike in inflation. Therefore, concerns of higher inflation appear to be overstated and a firm recovery in real GDP growth is expected to aid premium valuation of equities in 2021. In our view, the year 2021 will be a year, wherein bottom-up investment approach can be more sensible and shift of investors’ interest from growth-oriented sectors / stocks to value and cyclicals should remain visible.
…India Remains Promising despite Double Whammy of Rising Bond Yields and Oil Prices
In addition to rising bond yields, over 30% jump in crude prices in 2021 so far and resultant spike in fuel prices in the country raised investors’ eyebrows as higher fuel prices can stoke inflation. Further, this puts an additional burden on government’s fiscal. Our calculation suggests that every US$10 increase in Brent price may result in ~US$15-17bn incremental burden to government’s exchequer. While this may remain a key challenge for domestic markets in the near term, long term outlook of crude prices remains dismal and prices are unlikely to stay at higher levels.
Given, strong double-digit double digit expected growth in FY22E and steady growth thereafter to be supported by several reforms undertaken by the government to foster consumption and investment activities, India continues to offer promising growth opportunity to global investors. Therefore, any meaningful correction in the market due to rising bond yield and inflationary concerns should be used as an opportunity of bargain trading. In a nutshell, we continue to remain positive about India’s growth story and so domestic equities and premium valuation of market may sustain owing to promising growth outlook of corporate earnings.
The author is ED & CEO at Reliance Securities. Views expressed are his own.