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CLSA Sees Healthcare As Silver Lining Amid Rising Yield Gap

Global brokerage CLSA is cautious on the Indian equity market as the gap between earnings yield and bond yield near record high, but expects some green shoots in the healthcare sector.

The NSE benchmark Nifty has moved up 8 percent since it hit lows in March this year, amid rising bond yields. However, the price-to-earnings ratio for the index has not touched any new high since then, which adds to the worry over the market’s overall health, CLSA said in a note.

The 10-year bond yield, which is hovering around 8 percent, is unlikely to cool off given that the Reserve Bank of India hiked rates recently and may not go for one again soon, it said. Moreover, the weak fiscal situation combined with a worsening inflation outlook also makes for a grim picture.

While the implied risk premium is an esoteric calculation, the bond yield–earnings yield gap is a more straight forward and simple parameter. The gap is also one of the biggest determinants of the implied equity risk premium.
Mahesh Nandurkar, India Strategist, CLSA

The gap between bond yield–earnings yield is near a record high at 2.2 percent but such high yield gaps do not sustain, CLSA said citing three such previous instances of similar gaps.

Healthcare, A Silver Lining

CLSA added Sun Pharmaceuticals Industries Ltd. to its model portfolio with a two percentage point weightage, removing JSW Steel Ltd., as it believes earnings bottomed out in financial year 2017-18. With the compliance problems with the U.S. Food and Drug Administration behind it and specialty monetisation underway for the pharma major, CLSA expects recurring earnings for the company to double over FY18-20.

The brokerage has turned ‘Overweight’ on the healthcare sector as it is now showing signs of investor sentiment bottoming out.

“Sales of Indian pharmaceutical companies in the U.S. have stabilised sequentially and the commentary on pricing pressure has been improving. Valuations are reasonable,” said the CLSA note.