Here’s Why CLSA Fears Nifty Could Crash 30%

An unsustainable decoupling in Indian bonds and equity valuations could lead to benchmark index Nifty crashing by as much as 30%, according to research house CLSA.

The difference between the U.S. and Indian 10-year bond yields have fallen to a 13-year low of 3.3%, it said in its Sept. 29 note titled ‘Decoupled’.

According to CLSA, Indian equities are at a near-record valuation premium to peer markets as well as to domestic bonds.

“This indicates a kind of decoupling for Indian bonds as well as equity markets. We do not expect this to be sustainable and regard it as indicative of a very low margin of safety. A simple valuation mean reversion anchored on bond yields indicates fears of 30% downside in the Nifty.”

Indian markets have managed to remain relatively resilient in the wake of a global sell-off in equities.

The NSE Nifty 50 index has fallen roughly 2% year-to-date, while the Dow Jones has depreciated by 12.7% and the S&P 500 by 17.6%. The MSCI Emerging Markets Index is down over 28% in the same period.

The rupee has also performed better than emerging markets and even developed peers.

“India is the only market other than the U.S. where equity valuations are extended versus domestic bonds. At about 2%, the difference between India’s 10-year bond yield and the Nifty’s earnings yield is at a point at which negative equity returns usually ensue,” it said.

Highlighting more indications of negative returns in the next year, CLSA said the Nifty’s absolute PE is slightly below +1SD of its historical average and at levels where “positive equity returns are usually not forthcoming”.

“At the 98-99th percentile, India’s relative valuation to EMs and Asia ex-Japan is also near record highs.”

According to CLSA, the U.S., Thailand and India are the only markets where the 10-year bond yield minus 12-month forward earnings yields are high, suggesting that bonds are more attractive than equities in these markets at this point.