Home >Markets >Mark To Market >Covid infections soar, but US bond yields are the elephant in the room for markets

This week, a year ago, as India entered a nationwide lockdown, the Nifty 50 index fell to a low of 7,610. Since then, of course, the benchmark index has staged a stunning recovery, rising as much as 94%.

A year later, India is facing a second wave of covid-19, with cases rising in the key industrial state, Maharashtra. But markets don’t appear too perturbed by it. What is the explanation?

“In other countries, where the second and third covid-19 waves have happened, the performance of their respective stock markets has been a mixed bag. While in some countries performance has been weak, in many other instances, the second and third waves have not led to market movement as such," said Sanjay Mookim, head of research at JP Morgan India.

The big difference between a year ago and now is that the government has not announced any major lockdowns. “Even if there may be a second wave in India, you will not get specific Indian underperformance compared to emerging markets unless there are economic consequences. This will happen only in case of a lockdown, which I don’t foresee at this moment," Mookim added.

Additionally, it’s worth noting that the pace of vaccination is picking up. And while the rise in cases last year came as a surprise, this time around, the belief is that the level of preparedness is better.

Rise in the US bond yields is a drag on EM equites, including India
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Rise in the US bond yields is a drag on EM equites, including India

Nonetheless, the rise in covid cases isn’t the only worry the market faces. There is a rise in inflation and yields that is making some investors jittery. A recent survey of global fund managers by BofA Securities showed that for the first time since February 2020, covid-19 is no longer the biggest tail risk for the markets. Higher than expected inflation is the biggest concern, the majority of the respondents said, with the next biggest risk being a tantrum in the bond market.

“While the pandemic is not a worry for the markets anymore, the elephant in the room is the sharp spike in the US bond yields, which is a drag on emerging market (EM) equities, including India," said Ritesh Jain, a global macro investor and a former executive at BNP Paribas Asset Management India Pvt. Ltd.

Already, the central banks of Brazil, Russia and Turkey have raised rates.

“If the US bond yields don’t stop rising, then more and more EM central banks will have no choice but to raise their interest rates to support their currency and sacrifice their GDP (gross domestic product) growth in favour of the US," said Jain.

Oil prices are a big risk too, given the high level of imports and the impact this can have on the fisc. Prices of other commodities too have risen, posing a threat to corporate profit margins in coming quarters.

But these risks aren’t reflected in Indian stock valuations. The Nifty 50 index has declined only 3.7% after touching a high on 15 February.

“In the recent past, EMs including India have reacted to the strength in the US 10-year bond yields. There is still some room on the downside, though," said Amit Shah, head of India equity research at BNP Paribas.

In a report on 18 March, Credit Suisse Wealth Management India pointed out, “Our global investment committee recently changed its outlook on emerging market equities to neutral from outperform as the near-term prospect for the USD has improved due to the sharp rise in bond yields. We continue to believe the Indian equity market has been pricing in a lot of positives, and it may see some further consolidation."

To be sure, there are some positives. For instance, there is reasonable optimism on the earnings front. According to Shah: “The March quarter is set to be very strong. As companies announce the current quarter’s numbers, management commentary would allow us to get a good peek into how things will pan out in the financial year 2022."

But given where things stand on the valuation front, the risks outweigh the positives, and investors should tread with caution.

Harsha Jethmalani contributed to the story.

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