Home / Markets / Mark To Market /  This measure suggests market has bottomed out; but watch out

The Nifty index, which has suffered its worst sell-off, is offering yields similar to 10-year government securities. The bellwether lost 14.1% so far this calendar year, driving valuations lower.

This has shrunk the gap between the Nifty’s earnings yield and the 10-year bond yield. “The Nifty’s earnings yield is now only 0.2% above the 10-year-bond yield, which is nearly where the Nifty has bottomed on a few past occasions," said CLSA India in a note to clients.

The Nifty’s earnings yield has risen from 5.53% to about 6.5% in 2020. The earnings yield is the inverse of the one-year forward price-earnings ratio. The 10-year G-sec yield is hovering around the 6.14% mark.

However, investors should note that in some extreme cases, yield gaps have gone past these levels before. During the global financial crisis, the yield gap differential was as high as 5.6%. Such a risk remains high because of the slowdown and Covid-19 related concerns. “A global recession could further spike the earnings-bond yield. A full-blown global recession like the 2009 financial crisis resulted in spreads widening significantly to 500+bps," said ICICI Securities Ltd in a note to clients.

A cut in expected earnings could also see the yield gap rising. The 27% earnings growth expectation for FY21 may be revised downward, once the Covid-19 impact is factored in.

CLSA also said that with Nifty trading at 16 times one-year-forward earnings, longer-term equity returns may be mediocre going by past experience. So while earnings yield has shrunk, a lift-off may still be elusive.

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