India’s stock market in 2025 and the growing appeal of US bonds

India’s stock market enjoyed a bull run 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.

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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.

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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.

For the yield gap to move higher, the Nifty ought to fall from current levels as prices and yields move in opposite direction.

FPIs have sold shares worth ₹1.03 trillion in the cash market between 2 September and 20 December, per the National Securities and Depository Ltd (NSDL).

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The net profit of 4,370 companies listed on India’s stock market grew by just 4.84% to ₹3.75 trillion in the quarter ended 30 September, against a 38% growth to ₹3.58 trillion in the corresponding year-earlier second quarter, per Capitaline.

Domestic investors and IPOs

While domestic institutional investors led by mutual funds stepped in to absorb the FPI selling in the cash markets between September and December, primary issuances have resulted in supply exceeding demand.

DIIs net purchased ₹2.02 trillion in the cash market between 2 September and 20 December— ₹0.99 trillion more than what FPIs sold. However, total issuance (IPOs, offers-for-sale, and qualified institutional placements of shares) from September to November alone was ₹1.57 trillion, per Prime Database.

This resulted in an excess supply of ₹58,000 crore (or ₹580 billion) against demand in that period, based on Prime Database data. While FPIs did invest in the primary market segment over this period, heavy selling by them in the secondary market resulted in a market pullback of 7%.

The supply pipeline looks strong for the next year too. Sixty-two companies that have filed offer documents as of 13 December for approval by the Securities and Exchange Board of India are estimated to raise around ₹1.2 trillion, per Prime Database.

Also read | Record FII exodus shakes India’s stock markets even as domestic funds step up

If FPI outflows from secondary markets continue—foreign investors tend to invest in the primary segment and book profits in secondary market in India—domestic institutional investors can well absorb the secondary sales. But excess supply would leave India’s stock market subject to the vagaries of FPI activity.

“As far as FPI investment behaviour is concerned, the US market is by far the best market for them and there is no doubt that no other market right now compares with that,” said veteran investor Shankar Sharma.

“Therefore, money will keep flowing towards the American market and the American dollar, and emerging markets in general may not be in great shape,” he added. “The only contrarian trade I can look for is China.”

Nitin Jain, chief executive and chief investment officer at Kotak Mahindra Asset Management (Singapore), added: “In recent weeks, global investors have been watchful about EMs (emerging markets. Recent macro data like GDP has been unfavourable and corporate earnings have been weak.”

Coupled with high valuations—the Nifty is trading at a one-year forward price-to-earnings multiple of 19.57 times versus its historic average of 18.25 times—this could queer the pitch for markets unless corporate earnings improve.

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A corporate bounceback?

Some financial market constituents are confident of corporate earnings improving and DII support continuing in the face of likely FPI outflows in the secondary market.

While Kotak Securities expects Nifty earnings per share (EPS) to grow by just 4.9% to ₹1,036 in the current fiscal year (from 20% to ₹989 in the previous fiscal year), it sees a 16.4% EPS growth to ₹1,206 in FY26 and 14% to ₹1,372 in FY27.

However, if the US bond yields keep rising on fears of inflationary expectations fuelled by tariff hikes, it could put a pause on future rate cuts by the Fed, which during its recent policy meeting on 18 December halved its forecast for rate cuts in 2025 to just two. This could add pressure on Indian stocks and lead to further FPI outflows, narrowing the yield gap further.

“While there is a different class of FPI that invests in debt and equity of EMs like India, the narrowing yield gap affects the FPI equity investor too in light of the currency risk assumed while investing in risky emerging market equities,” said Madan Sabnavis, chief economist at Bank of Baroda.

Also read | Earnings growth slowdown appears temporary, says Franklin Templeton’s Hari Shyamsunder

However, S.K. Joshi, a consultant at Khambatta Securities, remains cautiously optimistic.

“Government spending, which slowed in the first half (of FY25) on account of the Lok Sabha election, could pick up in (the second half), resulting in an improvement in corporate earnings,” he said.

Government spending in the seven months through October stood at 42% of the budgeted target of ₹11.11 trillion for the full fiscal year (2024-25).

The US markets have outperformed Indian indices significantly since September. While the Nifty 50 has fallen by 7% from 25,378 on 18 September to 23,588 on 20 December, the Dow Jones has rallied 3.2% over the same period.

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