Photographer: Sanjit Das/Bloomberg

Auerbach Sees Stock Bulls Switch to Bonds If RBI Delays Cuts

  • Gap between bonds and earnings yield unlikely to narrow soon
  • Savings may move to gold if prices break $1,350, rupee weakens

Local investors pouring money into Asia’s second-best performing equity market this year may turn to bonds -- or even gold -- if the Reserve Bank of India delays further reduction in borrowing costs, according to Auerbach Grayson and Co.

Bond yields are higher than earning yields for the nation’s shares, and the gap may not narrow as the central bank isn’t expected to add to this month’s rate cut soon, Nikhil Bhatnagar, director of Asia sales in New York, said in an interview.

“If the RBI remains behind the curve on rates, we could see domestic assets rotate back into fixed income and gold,” he said.

The RBI cut its benchmark repurchase rate to a seven-year low on Aug. 2, after keeping it unchanged since October, to help boost an economy held back by Prime Minister Narendra Modi’s currency clampdown last year. But, it disappointed investors by maintaining a neutral stance, which has put a question mark on further easing.

The benchmark 10-year sovereign yield has climbed 10 basis points since the RBI’s policy meeting and remains among the highest in Asia. The premium the government bond yield commands over the S&P BSE Sensex’s earnings has widened to over 220 basis points after rebounding from a seven-year low in November, data compiled by Bloomberg show.

A slowdown in flows to shares may put the brakes on the rally that’s driven the Sensex to multiple peaks even after data highlighted weak spots in one of the world’s fastest-growing economies. That’s happened as investors embraced financial assets with gusto after the cash ban cooled returns from property and gold, a traditional favorite.

  • Local stock funds took in 411 billion rupees ($6.4 billion) in the April-July period, more than triple from a year ago, data from the Association of Mutual Funds in India show.
  • Inflows into balanced funds, which buy stocks and bonds, surged more than five times in the period to 301 billion rupees: AMFI
  • Gold ETFs, in comparison, saw an outflow of 2.6 billion rupees.

The gush of liquidity has left the Sensex trading at valuations that are 23 percent higher than the five-year mean despite weak earnings growth. The change in 12-month forward earnings estimates for Indian firms is close to zero, compared with a 7.8 percent increase for emerging-market Asia, data compiled by Bloomberg show.

Read more: Sputtering Earnings Behind Cruel Month for Indian Stocks

“Every economic indicator in India reflects an anemic economy, while valuations point to a terrific earnings cycle, which is an unsustainable situation,” Bhatnagar said. “India ranks lowest in terms of risk-reward at the moment.”

Earnings growth for companies in indexes may not recover until 2019-2020 as the economy grapples with the after-effects of recent policy changes, he said. A bleak earnings outlook and pricey valuations have recently soured the sentiment for Indian stocks among foreign investors, with August seeing outflows of $1.6 billion. The withdrawals have put the Sensex on course for its worst month since November.

Gold Catalyst

“Over the past three years many Asian markets such as Korea, Taiwan and Malaysia have gone through cyclical corrections for political or economic reasons and look much better in terms of valuations and earnings trajectory,” Bhatnagar said.

Meantime, a climb in gold above $1,350 an ounce could be a catalyst for households savings to move away from stocks. The price of gold rose 0.5 percent Wednesday and is sitting flat at $1,290.73 today. There’s another incentive: a strong rupee has kept prices in India, the world’s second-largest importer, from moving in tandem with global values.

“Gold is attractive since we’re probably headed into a bout of currency depreciation, which means in rupee terms, gold will outperform equities and bonds,” he said.

— With assistance by Swansy Afonso, Abhishek Vishnoi, and Ameya Karve

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