"Will the bull market sustain?" is the question uppermost in the minds of every stock market investor at this point. The spreads between yields on corporate 'AAA' bonds and short-term government paper may have an answer to it.
A study by Crisil Equities suggests that a sustainable bull trend in Indian equities is unlikely till the currently high spread of 199 basis points between yields on corporate bonds and treasury bonds slips back to its historical mean range of 110 basis points.
Historical data reveal a strong inverse correlation between the movement in credit spreads and performance of equity markets, the report says. For instance, during June 2001 to August 2002, when the average spread was above the historical mean at around 156 basis points, equity markets remained range bound with a negative bias.
The period between 2003 and 2006 was marked by lower average credit spreads of around 63 bps. This gave rise to a bullish phase that continued till early 2008. Since March 2009, credit spreads have declined by 24% from 260 bps to 199 bps, indicating an improvement in the risk appetite of the investors. However, the current spreads are still 88 bps higher than their historical average of around 110 bps, reflecting a degree of scepticism of fundamentals,
According to debt market experts, widened credit spreads signify higher degree of risk involved while buying a debt instrument. In normal market conditions, credit spreads (loosely termed as risk premium in layman's language) would be much lower than current levels.
According to the fund manager of PSU bank-promoted fund house, higher risk premium (on corporate bonds) could not be entirely due to credit risk, but also because of liquidity risk.
What ever said and done, it is logical that industries get cheaper loan to do more business and improve their profits. Only in such situation, you would have fundamental reason for the market to rally and sustain the momentum.
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