A study by Crisil Equities suggested that a sustainable bull trend is unlikely in Indian equity markets, until the currently high spreads of 199 basis points (bps) between yield on corporate AAA bonds and treasury bonds slip back to its historical mean range of 110 bps.
Historical data reveals a strong inverse correlation between the movement in credit spreads and performance of equity markets.
Credit spread is a leading indicator of macroeconomic business conditions and often marks turning points in the business cycle. It functions counter-cyclically, narrowing during business expansions and widening during contractions.
Crisil Equities has observed a strong inverse correlation between the movement in credit spreads and performance of equity markets, with the equity markets showing a time lag of 9-12 months.
During June 2001 to August 2002, when the average spread was above the historical mean at around 156 basis points, equity markets remained range bound with a negative bias and the S&P CNX NIFTY delivering around 7% returns.
Thereafter, CY2003 to CY2006 was marked by lower average credit spreads of around 63 basis points. Correspondingly CY2003 marked commencement of the bull trend that continued until early CY2008.
Chetan Majithia, head, Crisil Equities, said, ?We have observed a similar correlation between the movement in credit spreads and the equity market performance in various international markets such as Dow Jones Industrial Index in the United States, FTSE in the United Kingdom and emerging markets like Hang Seng of Hong Kong. The combination of larger spreads and sceptic investor participation in the market strengthens our view that the current equity market rally may not be sustainable.?