The last four years have seen equity and debt markets moving in opposite directions. While the equity valuations have soared the debt markets have seen not so good times. The BSE sensex has risen from less than 3000 in March of 2003 to more than 15000 currently. That is more than five fold increase. The yield of 10 year government bonds bottomed out at 4.97 per cent in October 2003. The current yield on 10 year government bonds is 7.92 per cent. (The price and yield of bonds move in opposite direction). For a 10 year bond with coupon payment of 7 per cent this would have lead to price loss of 20%. If you think that government bonds are insured against all risks, think again.

Looking into rear view mirror is almost never a good way to predict the future. The sensex lost one third of its value in eleven years from 1992 to 2003. The debt market in the years 2001 and 2002 had given a return close to 20 per cent on the back of falling yields. What followed could not have been predicted by looking at these results. Current fundamentals and valuations are better inputs for evaluating the future prospects. The Price Earnings ratio of sensex was close to 11 in middle of 2003. That means for every one rupee of earnings from sensex one was paying eleven rupees. While the 10 year bond yield of 5 per cent during the same period implied that for every one rupee of earnings from the bond one was paying twenty rupees. In retrospect it is not difficult to see that stocks were much cheaper than bonds. It was time to buy stocks.

Currently 10 year bonds yield of 7.92 per cent implies for every one rupee of earnings from the bond one has to pay close to 12.7 rupees. The price earnings ratio for sensex currently is implies that one is paying 22 rupees for every rupee of earnings. Clearly the value equation has changed. Even if one takes into account that earnings of companies tend to rise while the interest payment on bond is fixed increased allocation on bonds makes sense. The momentum in stock market might last for sometime but the effect of fundamentals will be felt sooner or later. It seems like a time to accumulate some at least some debt exposure through hybrid funds.