Expert Opinion

Published: Dec 29, 2021
Updated: Dec 29, 2021

Stocks take a hit from rising bonds

The bond market has sprung back to life over the past few weeks with yields shooting higher and shaking faith in the stock market rally. Rising bond yields have triggered sharp falls in the NASDAQ. Tesla tumbled more than 30% over the month to March 7, with Ark’s Innovation ETF down around 26% and Amazon off by roughly 12%.

Indian bond yields started surging from February 2021, tracking a rise in US Treasury yields. Indian bond yields have seen an upward bias on the RBI’s assurance that it would provide ample liquidity and ensure a smooth government-borrowing programme. The yield on 10-year bonds in India moved up from the recent low of 5.76% to 6.20%, sending jitters through the stock market. In India, during the first half of 2020-21, bond yields were below 6%. However, it changed after the budget when the government raised its borrowing programme for the current fiscal. In the US, bond yields were 0.31% in March 2020, which stayed at 1.40% recently.

While the stock market soared as bond yields hit historic lows last year, equities can conversely suffer here from higher yields, as bonds start to offer more competition to yieldseeking investors. Rising yields in recent weeks have been a mixed bag for stocks. Bond yields play an important role in FPI flow. When bond yields rise, FPIs move out of equity markets. When bond yields go up, it results in capital outflows from equities into debt. A higher return in treasury bonds leads investors to move their asset allocation from more risky equity markets to treasury bonds, which is the safest investment instrument. So, a continuous rise in yields in developed markets puts more pressure on equity markets. Amid rising bond yields, FPIs pulled out Rs 5, 156 crore in March so far, as overseas investors pulled out a net Rs 881 crore from equities and Rs 4, 275 crore from the debt segment between March 1 and 5, taking the total net withdrawals to Rs 5, 156 crore.

INVERSE RELATION

Bond yields are inversely proportional to equity returns. When bond yields decline, equity markets tend to outperform, and when yields rise, equity markets tend to fall. Traditionally, when bond yields go up, investors start reallocating investments away from equities into bonds. In addition, a rise in bond yields raises the cost of capital for companies, which in turn reduces the valuations of stocks. Amid the rising yields, for the week ended March 7, 2021, the BSE Sensex lost 2.7 per cent. The broader indices, Nifty Midcap-100 and Smallcap-100, outperformed at 3.5 per cent and 3.9 per cent respectively. On the sectoral front, barring the PSU bank index, all the indices closed higher.

Most of the emerging markets are facing FPI outflows, with higher outflows witnessed in Taiwan and South Korea. This calendar year to March 7, 2021, Taiwan has seen $ 9.4 billion of FPI outflows whereas South Korea has seen outflows of $ 8.1 billion.

INFLATED P/E VALUES

With the rising bond yields, the calculation of Price-Earnings projections is also set to change, as there is no relevance of past P/Es anymore. The changes in P/E will have to account for current bond market conditions. Even otherwise, the price-book value ratio is still over 12 years high as far as India’s markets are concerned. In these conditions, many of the fundamentals have lost their relevance in overall market conditions.

Going forward, the focus will be on economic numbers and the pace at which India gains the economic momentum back. However, as markets continue to surge with high valuations, the possibility of profit-booking remains as a concern, which may slow down the pace of net flows in to markets.

(Dr VVLN Sastry is a post-doctorate in Economics, a PhD in Law and Public Policy, a passionate economist and a financial and law expert.)