Indian equity markets witnessed a speedy recovery from the lows of March 2009. Now, after a great run, investors are beginning to wonder if valuations have become stretched.
To answer this question, we compared the yield of the 10-year benchmark GOI paper with the Nifty's yield. While equity investments are regarded as risky, government paper is considered to be a risk-free investment. So if investors are to invest in equities, they must be compensated with a premium over the risk-free rate of return.
On comparing the yield of the Nifty (1/Price-to-Earning Ratio*100) with that of the 10-year benchmark GOI, we found that currently the GOI's yield is 1.75 times that of the Nifty. In other words, investors are not earning a premium by investing in equities.
If we look at historical data, from mid-2005 until October 2008 the yield of the 10-year benchmark was always higher than that of the Nifty. From October 2008 to March 2009, investments in equities yielded more than the GOI. But from the start of the bull run in March 2009, this began to reverse (see graph). Hence, October 2008 to March 2009 was the best time to invest in equities.
An investor might get discouraged and believe that there is no point to investing in equities now. However, remember that the figure we have looked at is the Nifty yield. If you look around, you will still find many stocks that are offering a yield that is higher than that of the 10-year GOI. If the stock's fundamentals are strong and its growth prospects attractive, you could go ahead and invest in it.
The data mentioned above (yield from the Nifty being higher than that from 10-year GOI during the downturn) underscores what John Templeton, one of the greatest value investors of all times said: “Invest at the point of maximum pessimism.”
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