The Indian equity market is likely to take a short-term correction. Usually, the relative discount/premium of benchmark bond yields in a country over that of its earnings yield (of its respective equity index) plays an important role in the allocation of money into equities or elsewhere. In the case of India, the ten-year g-sec yield is today much higher at 7.96% per annum as compared with the earnings yields of Sensex (4.2%).
So, in effect, one could say that bond markets are much more attractive as compared to equities from an investment point of view. According to a portfolio manager, Indian corporate bonds are expected to give yields of 11% per annum?8% in the form of coupons and 3% from currency appreciation. While the recent rupee depreciation could make investors rework the math, on an overall basis, FIIs are still likely to be more interested in Indian bond markets.
This is not so in the case of markets like Taiwan, Hong Kong, China, Thailand and Malaysia. For instance, in China, ten-year bond yields are much lower at 3.3% as compared with its earnings yields. Earnings yields are calculated by dividing annual profits of Sensex companies by its market capitalisation. An easier way of calculating the earning yield of an index is also to reverse its price to earning ratio (and multiply it by 100).
HSBC has already put a ?neutral? rating on China against ?underweight? for India. This, in other words, means that the MSCI China index will perform ?approximately in line? with the MSCI Asia Pacific Index over the same period, while the MSCI India Index will underperform the regional gauge.
Other countries having earnings yields of its equity indices quoting at a discount to its bond yields were the Philippines, South Korea, Japan, Pakistan and Indonesia. While the Jakarta Composite had the highest discount of 6%, it was followed by the Sensex at 3.8%, Nikkei 225 at 0.5% and South Korea?s Kospi at 0.4%.
Emerging equity markets got a record $60 billion in 2009, excluding China and Malaysia, according to Credit Suisse data. India received a sizeable chunk of it; $17 billion, which was next only to South Korea (which received $24 billion). While for the current year India has received close to $6.3 billion already, what is worrisome is its relative valuations. In terms of FY11 forward earnings, the Sensex is still at relatively higher levels as compared with most markets, except for Japan and Malaysia.
At the macro-level, the Eurozone worries are already increasing fear levels?as measured by the global volatility index?which, in turn, is affecting the overall inflows into emerging markets. This trend is likely to affect markets like India much more, given their relatively unattractive valuations.