Are the markets peaking out?

Markets have nearly doubled from their March lows. This rise has caught nearly every market player by surprise. There is still wide skepticism about the future sustainability of this rally as not only do the markets appear fully valued, global economic indicators are still far from being comfortable. Also liquidity which has been a major driver of this rally is likely to come under pressure in the near term. While in US and many other developed countries interest rates are likely to remain low, RBI is likely to start tightening money supply soon. This is likely to increase the yield on corporate bonds and G-Sec. This will not only impact corporate earnings going forward as rise in interest rates will raise cost of borrowing and depress demand for consumer goods, equity as an asset class will start looking less attractive compared to debt. Historically too interest rates especially G-Sec yield and stock market indices have had a negative correlation. This fact has made a lot players conclude that markets could be near to their peak. However we feel that though this may be a cause of concern, yet an alarming situation is still a considerable distance away. Historically, whenever G-Sec yield has reached higher than equity yield by 4% or more, stock markets have peaked out. The recent rally has not reached this situation yet as the yield gap, equity yield minus G-Sec yield, is presently around -2.7%. In September 1994, February 2000 and January 2008, when previous bull markets peaked out with Sensex at 4,630, 5,933 and 20,873 levels respectively, the yield gap was between -4 to -5%. This means the alarming situation will rise only if either the equity markets rise very sharply from here, around 20%, in the next few months or the G-Sec yield rises very sharply from here. Possibility of G-Sec yield rising so sharply in the near future appears very unlikely. Also the equity yield itself is going to steadily rise in the next few quarters as corporate earnings keep improving. Hence equity markets have a long way to go from here before they peak out.