X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Has the Market Bottomed Out? - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Has the Market Bottomed Out?
Jun 11, 2018

Madhu Gupta

The stock market is like a swinging pendulum.

But unlike a pendulum, it's very difficult to predict how the market will swing.

The Indian markets remain volatile. After shedding 10% from peak value in 2018, the BSE Sensex recovered nearly 8.8%.

But uncertainties over the global trade relations and expectations of faster rate hikes by the US Fed are the short-term headwinds.

Is there a more rational measure to study the direction of the market?

Yes, there is.

It's the yield-spread or the gap between the risk-free return and the earnings yield.

The risk-free return is the return guaranteed on a safe asset such as a 10-year government bond that enjoys sovereign backing. This asset has literally zero risk of default. The return earned on it is known as the sovereign bond yield.

In comparison, the earnings yield (i.e. the ratio of net profit to market capitalisation) is far riskier and volatile. It is not guaranteed and depends on the financial health of the underlying companies.

The difference between the bond yield and earnings yield is known as the yield spread.

During boom times, companies flourish, resulting in high earnings growth. This manifests in the form of higher earnings yield as compared to the bond yield. So, investments flow in to equities, rather than bonds, fueling a stock market rally. In such a scenario, the yield spread can narrow or turn negative.

But during a recession when corporate earnings take a hit, the falling earnings yield make stocks less attractive. This results in funds moving out from the stocks into bonds. In this case, the yield spread widens.

The yield spread has widened in the past few years.

Recently, the yield on the 10-year government bond crossed the 8% mark, reaching a 3-year high level. This has come on the back of a 0.25% rate hike by RBI after a gap of around four years.

As a result, the yield spread between the 10-year government bond and the BSE-500 companies has widened to 4%. This is 1.7% higher than the 10-year average yield-spread of 2.3%.

For the yield spread to revert to mean, either the risk-free bond yield needs to contract or the earnings yield needs to improve.

With hardening crude oil prices, rising fiscal slippages, and faster than expected rise in the US treasury yields, bond yields are not expected to temper down anytime soon.

Further state-owned banks, the biggest holder of bond securities, are not actively participating in the bond markets. The resulting high supply of bonds has exerted pressure on prices pushing up their yields.

What about stock returns or earnings yield then?

As India Inc continues to grapple with low capacity utilisation and sluggish investment demand, earnings are not likely to improve very soon.

So for the yield spread to narrow down, stock prices most likely will have to correct further.

Having said that, factors such as recovery in rural demand, faster resolution of bad loans in the banking system, and the government's strong focus on infrastructure are expected to spur economic growth and boost corporate earnings in the long run.

Until then, the market is likely to remain in a bear grip.

Madhu Gupta

Madhu Gupta (Research Analyst), ValuePro has a post graduate degree in both physics and finance. Having worked with India's leading economic research agency, she has a natural flair for numbers and analytics. She brings with her a near-decade long rich experience in the field of finance. A firm believer of the principles of value investing, she looks for robust businesses with durable competitive advantages.

Equitymaster requests your view! Post a comment on "Has the Market Bottomed Out?". Click here!

  

More Views on News

Two Meetings That Nailed the Idea of Owning Brilliant Smallcaps Without Buying Them (The 5 Minute Wrapup)

Mar 22, 2018

Certain blue chips hold the potential of delivering returns comparable to small-cap stocks. With these stocks, you can get the best of both worlds.

What They Forgot to Tell You About Sensex at One Lakh (Profit Hunter)

Nov 29, 2017

Stocks that could beat Sensex returns in the long term.

Overthrow Your Financial Evils This Dussehra (Outside View)

Oct 17, 2018

PersonalFN explains the key things to do to overthrow financial evils and make a new beginning and march ahead to live a healthy financial future this Dussehra.

Why LIC Will Continue to Bailout the Govt This Year as Well (Vivek Kaul's Diary)

Oct 17, 2018

With central GST collections unlikely to meet the target, the government will be desperate for money during the second half of the year.

Work Timings Prevent You From Investing? An Efficient Robo-Advisor Can Help (Outside View)

Oct 17, 2018

PersonalFN explains a robo-advisory platform can save time and can help you manage your investments on-the-go.

More Views on News

Most Popular

Don't Panic in This Falling Market... Do This Instead(The 5 Minute Wrapup)

Oct 5, 2018

Find companies with long term durable moats, which are correcting with the current broader market sell-off.

Taxpayers to pay salaries of CEOs/CIOs of Mutual Funds(The Honest Truth)

Oct 5, 2018

Ajit Dayal on the crisis in the market and in the mutual fund industry.

This Market Crash could be the Biggest Wealth Creating Opportunity Since 2008(Profit Hunter)

Oct 8, 2018

While widespread fear is the friend of a value investor, serving up bargain purchases; personal fear is an investor's biggest enemy.

IPO Market Feels the Heat of the Market Crash(Sector Info)

Oct 12, 2018

The sentiments in primary market have also deteriorated amid the stock market correction. Most listed IPOs of 2018 are trading below their issue price.

Are These Deep Corrections a Buying Signal?(Chart Of The Day)

Oct 5, 2018

The correction has bought many good companies to reasonable valuations. Go against the wisdom of crowd and Buy.

More

Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Oct 17, 2018 (Close)

MARKET STATS