Indian stocks’ de-coupling looks unsustainable as analysts warn of 30% crash

The domestic market is vulnerable to a crash due to the apparent de-coupling of Indian equity and bond markets from the global turmoil.

CLSA India warned in a note on September 29 that the Nifty 50 is vulnerable to a crash as big as 30 percent from current levels because of the inflated valuations of the market.

CLSA doesn't expect de-coupling to be sustainable and thinks it's indicative of a low margin of safety.

Despite a soaring US dollar and fears of a global recession, the Indian stock market has fallen less than most developed and major developing markets.

The Nifty 50 index has only hit a two-month low in the sell-off of the past few sessions, while the S&P 500 is sitting at a two-year low.

Despite the Reserve Bank of India raising interest rates by 140 basis points since May, the domestic government bond market has done well.

The difference between the 10-year Indian government bond and the US bond of the same type is at its lowest point in 13 years. The US 10-year bond yield has gone up 150 basis points in the last two months, while Indian gilts have gone up 25 basis points.

A consumer-led revival in the domestic economy and early signs of a multi-year capital expenditure cycle in the private sector have contributed to the resilience of the domestic stock and bond market.

CLSA believes that the bond market will eventually return to the five-year average spread of 4.7 percent to the US Treasury bond yield, which will peg the 10-year local government bond yield at 8.25 percent.

The rupee may not be ruffled by the Dollar liquidity crisis.

The widening of the gap between the earnings yield of Nifty 50 and that of the 10-year government bond is indicative of negative equity returns going forward, according to a recent report.

The current earnings yield of Nifty 50 companies is more than 200 basis points higher than the government bond's yield.

The stock market tends to give a low return over the next 12 months when there is a wide difference between bond and earnings yield.

CLSA believes that a return to historical average difference of 100 basis points between the government bond yield and earnings yield of Nifty 50 will push the benchmark stock index to 13 times one-year forward earnings from 18.3 times currently.

The mean reversion in bond market and equity market valuations, as well as the risk of investors being caught on the wrong foot in their expectations of interest rate hikes by the Reserve Bank of India, are concerns of Kotak Institutional Equity.

The US Fed's reiteration of raising interest rates aggressively to cool down multi-decade high inflation will dash Indian market's hopes of a de-coupling from the turmoil in global markets

Kotak Equity said in a recent note that the Reserve Bank of India may have to raise policy rates beyond levels justified by domestic inflation.

The high valuations of Indian stocks and threats to the idea of de-coupling from global markets will cause investors to suffer.