Currently earnings yield of the NIFTY50 index exceeds bond yield by 45 bps and such instances have provided high expected returns in the past. Examples include ‘Demonetisation’ (44 bps) and ‘Taper Tantrum’ (+44 bps). However, the environment of a global recession could result in further spike in earnings–bond yield. A full-blown global recession like the GFC of 2009 resulted in spreads widening significantly to 500+ bps.
Pre-emptive stimulus missing in past events; will reduce the probability of a recession: Unlike the above events, which caught policy-makers unawares, the COVID-19 episode is being carefully monitored and pre-emptive measures have been taken by governments and central banks through fiscal and monetary stimulus which reduces the probability of a recession.
Lower oil price is a stimulus for India; however, INR depreciation is a key risk: Given India’s net oil import status (85% of domestic demand imported), oil price decline is a boost for government finances, stimulus for consumption, and reduces input costs, leaving apart its negative impact on upstream companies. However, the more than normal slide in oil prices could have implications on the stability of financial markets.
High frequency data for Jan-Feb’20 indicates a pick-up in economic activity in India (PMI, power demand, coal mining, etc.) which along with corporate tax cuts, soft commodity prices, treasury gains, and mean reversion in profitability of stressed sectors will continue to support earnings in Q4FY20. However, COVID-19 impact in Q1FY21 will be key.
Large section of equity markets yielding more than bond yield: 30 of the 50 NIFTY50 stocks have a forward earnings yield of >6%. Using trailing earnings for a larger universe, 484 stocks of the top 1,000 universe currently yield >6%.
Outlook: Given the steps by policy-makers, we assign very low probability of a global recession and view the current environment of earnings yield exceeding bond yield as an opportunity to buy equities.
Our top picks include: Bharti Airtel, NTPC, Titan, Jubilant Foodworks, HUL, UltraTech Cement, Cipla, SBI Life, Balkrishna Industries, Brigade Enterprises, Century Plyboards, Havells, Indigo, and Cholamandalam Investment and Finance.