Bottomline: It’s time to get real about investments

It isn’t Armageddon for equity investors, but spiking bond yields are nary a good sign. The chatter on the street is all about US bond yields and how they will impact equity and other risk-asset valuations. Also, how rising yields may actually be good, as it could indicate economic recovery. Well there’s some basis to these arguments, but many of these connections are a little stretched. So, it helps to have a clearer perspective. Here are some findings that you could make a note of.

We decided to look at how US 10 year bond yields, S&P-500 and US GDP growth correlate with each other. What we found is that yields and equities have a strong negative correlation (-0.8). So, a rise in yields could hurt equity valuations. The relationship between yields and real GDP is also negative—low / declining interest rates cause GDP to expand. However, the caveat here is that GDP growth rates and yields have a weak link. What this suggests is that, a change in yield may not induce a correspondingly strong change in GDP growth.

 

Now let’s look at what the relationship is between equities and economic growth. While there is a strong positive correlation between the economic trajectory of an economy and the value of stocks—as GDP grows, stock values will grow—there is, again, a very weak link between annual GDP growth rates and stock returns. Here 2020, is a good example of a calendar year that saw the S&P-500 deliver 15.8 returns even as the US economy shrunk by over 2 percent.

 

Some of this, could also be because equities tend to run more on expectations than delivery. But if that’s the case, a high growth in 2021 won’t necessarily promise high equity returns. That’s something to chew on.

 

What’s also interesting to note, is that while there is a strong correlation between corporate earnings and stock valuations, the correlation of BSE-Sensex earnings with GDP growth is only moderate (<0.5). This indicates that earnings growth need not keep close pace with economic growth. What this could also suggest is that you need to pick your stocks well, if you want to ride the recovery, as the broader indices may not adequately capture the trend. 

As with all data, your start and endpoints can make a big difference to the outcomes. Here, the returns in real estate and equities are an important case in point. While those in the realty business argue property investment returns have outperformed equity, equity buffs project a contrary view. The truth lies somewhere in between.

We looked at data from 2010 for realty and equities, with two starting points: 2010 and 2013. Interestingly, while realty delivered a return of just 54 percent from 2013 to September 2020, the Nifty almost doubled. But if you shift the start point to 2010, realty values have in 2020 were 2.5x vs 1.8x for the Nifty.

 

 

What’s also important to note in realty, is that just like in stocks the returns won’t be uniform. In fact Residex Index data reveals that 13-year returns in the NCR region have actually been negative. Pune, on the other hand, delivered 60 percent gain—though nothing to crow about for a 7-year period at under 7 percent.

After a hiatus, the real estate sector seems to be showing signs of life. With RERA in place, a lot of stress already factored in, low-interest rates and more sensible pricing by several developers, activity in the residential sector seems to have revived. And while there is stress in the economy in certain lower-income brackets, good tidings with the digitalization wave for IT/ITES augur well for hiring in the white-collar segment.

Managements of several realty companies have told CNBC-TV18 that things are looking up on the sales front and there could be a possibility of price improvement as well.

A report by Anarock shows that a big overhang for the sector, unsold inventory, is down 19 percent from its peak of 7.9 lakh units in 2016, and cities like Mumbai and Bangalore saw a 6 percent decline in inventories in 2020 vs 2019. The consultant, while outlining its outlook for 2021 says: “The Indian residential real estate is also entering a new decade. 2021 will undoubtedly be a year of recovery. While a new peak may not be attained immediately, it is anticipated that new residential launches may gain some momentum”.

The Anarock outlook is quite guarded, but brokerage Jefferies makes a stronger case in its report India Property: 2021 Outlook - A New Cycle Begins, in which it bets on a new upcycle. The report argues: “A new residential cycle start should become evident over 2021 as both end-users and investors get back into action. We expect residential sales to cross 2019 levels, inventory to fall to 8-year low by end'21 and prices to rise by 10 percent + over next two years”.

Given the historical evidence, it may not be amiss to expect that realty prices could see a sudden, sharp surge in the coming one to three years, before it settles down on a higher plane. So, timing your investment could be tough, but if you have a slightly longer-term investment horizon, or if you are looking to buy a home, this could be a good time to buy into realty. And if you are looking to ride the economic recovery, buying a real asset like realty should help you capture the trend.

But, like mentioned earlier, what particular realty asset you invest in—the development, the locality, the city et al—will go into determining the returns you generate. So, do your homework well.