Stocks Back in Limelight as 3-Year Run Makes Indian Bonds Pricey

Updated on
  • Correction offers ‘cheaper’ entry point in stocks: Julius Baer
  • Local notes will start ‘underperforming’ emerging markets: BBH

It’s time to make the switch to Indian equities from the nation’s bonds, as Prime Minister Narendra Modi boosts spending to counter the impact of his shock currency recall on growth in Asia’s third-largest economy.

Rupee sovereign notes, emerging Asia’s best performers in the last three years, are seen offering a more subdued return as India’s central bank nears the end of an easing cycle that began in early 2015. Equity valuations relative to bonds are the most attractive since 2013, according to Morgan Stanley, which has India among its top emerging-market picks.

“Policy makers would move away from monetary stimulus to fiscal stimulus, and the thrust will be on infrastructure building and structural policy shifts,” said Sunil Subramaniam, Chennai-based chief executive officer at Sundaram Asset Management Co., which oversees the equivalent of $3.9 billion. He favors metal makers, commodity producers and energy companies.

Modi last week announced sops for the poor, small businessmen and farmers -- sections most affected by his Nov. 8 decision to suck out 86 percent of the nation’s currency in circulation. Morgan Stanley predicts economic growth, hurt by the currency ban, to start recovering from the second quarter of 2017, as consumption and exports recoup. The U.S. bank forecasts the benchmark S&P BSE Sensex to return 14 percent next year, it said in a report last month.

Benchmark sovereign bonds on Friday capped their best annual performance since the global financial crisis amid record debt purchases by lenders, after the central bank boosted cash availability in the financial system and deposits surged following the government’s recall of high-value currency notes.

Read: Bonds in India See Best Year Since 2008 on Modi, RBI Surprises

The 10-year yield plunged 125 basis points in 2016, taking its slide over the last three years to 231 basis points. The Bloomberg India Local Sovereign Bond Index climbed 15 percent in 2016, and the Sensex rose 2 percent. That’s after the equity gauge tumbled 4.5 percent in the December quarter as the cash ban soured sentiment.

“We now have a good buying opportunity as the recent correction offers a cheaper entry point,” said Diego Wuergler, head of advisory solutions for the Middle East at Bank Julius Baer & Co.’s $327 billion wealth-management arm. “Equities should be preferred in any country which is implementing structural reforms,” he said, adding that Indian bonds “are not particularly attractive in terms of yield, nor are they cheap.”

The 10-year yield fell four basis points to 6.40 percent on Wednesday, taking its decline in the new year to 12 basis points. A drop below 6.30 percent won’t look “justified,” said Harihar Krishnamoorthy, Mumbai-based treasurer at the local unit of South African lender FirstRand Ltd. The Sensex headed for a second day of gains.

The premium the bond yield commands over the Sensex’s earnings yield shrank to a seven-year low in November. It has since widened to match levels last seen in mid-2013, just before the start of a rally that lifted the Sensex for six straight quarters through March 2015, data compiled by Bloomberg show.

Higher commodity prices and a weaker rupee could prompt the Reserve Bank of India to keep rates on hold again at the February review, according to Brown Brothers Harriman & Co. A Bloomberg survey shows economists predict the repurchase rate to be cut by just 25 basis points in the next 12 months, adding to six reductions in the last two years.

“With inflation likely to reverse and move higher and the central bank’s easing cycle on hold indefinitely, Indian bonds will start underperforming” emerging markets, BBH’s strategy team wrote in a December report. The “underperformance” of Indian equities relative to emerging markets “should ebb a bit,” the strategists wrote.

While global funds have been selling both Indian bonds and stocks of late, the local equity market still ended 2016 with a net inflow of $2.9 billion. In comparison, foreign holdings of rupee denominated government and corporate notes declined by 306 billion rupees ($4.5 billion), the most in three years.

“On equity markets, we believe India will exit the low return environment of the past two years, thanks to better equity valuations,” Morgan Stanley analysts including Chetan Ahya and Ridham Desai wrote in their report.

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