At $ 160.7 trillion, the Global Bond Market is now bigger than the Global Equity Market, which is around $ 158 trillion. The USA 10-year yield is at 4.97%, India’s G-Sec yield
% and Japan’s 30-year yield at a record 4.08%, bonds are sending a powerful signal. As America’s annual interest bill crosses $ 1.25 trillion, driven by a national debt that has surpassed $ 40 trillion, the linkage between Equity Yield and Bond Yield is evident today.
Bonds determine the price of money. They set the rate at which Governments borrow, the rate at which Corporations finance themselves and the rate at which future cash flows are discounted to arrive at the present value of any asset. When Bond Yields are low, Future Earnings are worth more and vice versa. This mathematical relationship sits beneath every Equity Valuation in the world. But the average Investor is addicted to Equity, as high P/E ratios were a logical response in a world where Government securities yielded 1-2%.. But today the situation has changed dramatically, with the Global Bond Market exceeding the Global Equity Market capitalisation by more than $ 2 trillion.
India’s Bond Market is around Rs 61 trillion as of date, up from Rs 17.5 trillion a decade earlier, with a CAGR of approximately 12%, and our Government debt is around Rs 219 trillion, making a Fixed Income Market of Rs around 280 trillion, which is almost 60% of India’s total Equity Market Capitalisation. When Governments need to borrow at this scale, they need to offer attractive yields, as reflected by the recent FCNR (B) borrowings. These yields become the reference point, the risk-free rate, against which every other asset, including Equities are priced. Every Equity Valuation model discounts future corporate cash flows back to a present value. The discount rate is the risk-free rate on Government Securities, and hence if the risk-free rate rises, valuation of equities falls and vice versa. Moreover, global Investors continuously compare the returns available across countries and asset classes. The yield difference between Indian Bonds and US Treasuries does influence the attractiveness of Indian assets to foreign investors.
The real question for Equity Investors is not simply whether Bond yields are high or increasing. It is whether the level of Equity Valuations adequately compensates investors for the Equity risk they are taking relative to the now available return on Government Bonds. Comparing the Earnings Yield on Nifty 50 and 10 Year G-Sec Yield from 2015-2026 we get a powerful message: The Equity-Bond Yield spread in 2026 @-1.96% is higher than 2018 and 2020 when spreads were -3.52% and 3.21%, respectively. But in 2020, government bond yielded only 5.89%, which is around 7% today. Hence, if we go for Equities now, how much risk can we take? A business whose earnings are growing at 15-20% can give a P/E above 20 and capital gains. But if the earnings growth is 8-10% per annum, then is it worth taking the risk in equities when we can get risk-free bonds at 7%?
What do you think? Where are we on the Street?