India's Stock Market in 2024 and What's Weighing on it Next Year

Surging bond yields are predicated on fears of rising inflation expectations in the world's biggest economy

- Ram Sahgal

India's stock market enjoyed a bull run over the past five years, but several factors, chiefly rising US bond yields and a risk of slowing domestic corporate earnings, are likely to weigh on it in 2025.

Rising US bond yields amid disappointing domestic corporate earnings growth and high stock valuations in India have resulted in a recent rush of foreign fund outflows. While domestic institutional investors (DIIs) can absorb some of the sales by foreign investors, increasing primary issuances mean a glut in stock supply, which can impinge the stock markets negatively in 2025.

US bond yields have risen even as the US Federal Reserve has cut its key policy rate by 100 basis points since mid-September, to 4.25-4.5% now. This has resulted in global fund outflows from emerging markets such as India to the safety of the US dollar. (A basis point is one-hundredth of a percentage point.)

Surging bond yields are predicated on fears of rising inflation expectations in the world's largest economy, fuelled by a resilient US economy, and threats of higher import tariffs by US president-elect Donald Trump once he takes office on 20 January.

While the US 10-year bond yield has risen from 3.71% on 18 September—when the Fed began to cut rates—to 4.52% on 20 December, the Nifty fell 7% to 23,588 points over the same period, reducing the returns for the year.

This has caused the yield gap—the difference between the Nifty earnings yield (the inverse of the price-to-earnings ratio) and the US 10-year bond yield—to shrink to near zero from 40 basis points on higher foreign portfolio investor (FPI) outflows from India in that period.

The Nifty earnings yield should typically be higher than the US treasury yield as stocks are a riskier investment than the US benchmark bond. If the yield gap is near zero or negative, that acts as a disincentive for FPIs, who prefer the safety of US bonds over Indian equities.