The global investment bank said that it arrived at the valuations for the Sensex by using top-down estimates for earnings growth i.e. 15 percent and a 16.5x forward P/E multiple.
The S&P BSE Sensex rose over Mount 33K in the calendar year 2017, but a global investment bank sees the index slipping towards 32K towards the end of the next year, BofAML said in a report.
The global investment bank said that it arrived at the valuations for the Sensex by using top-down estimates for earnings growth i.e. 15 percent and a 16.5x forward P/E multiple. The S&P BSE Sensex currently trades at 18.5x forward which is well above its historical average of 15.3x.
Large positive returns from current levels are only possible if the current elevated P/E multiple sustain so that the growth in earnings can drive stock prices. But, downgrades to estimates are still likely in 2018, said the note.
Here are top key themes for the year 2018:
Global Macro Recovery, a key risk:
The year 2017 has been a significant year for global assets. Bloomberg world exchange market cap is up 38 percent or $25 trillion this year. Bonds saw action too, strengthened in most regions. Indian equities have also risen significantly – MSCI India is up 25 percent while the MSCI India midcap index is up 38 percent.
Indian equities have benefited from the global assets inflation and going forward global fortunes will have a large impact on prices in India in 2018. BAML strategists forecast a 1HCY18 top in risk assets as the last effect of QE continues, combined with tax reforms in the US.
The global investment bank believes a 1H flash crash is likely as central banks liquidity begins to withdraw. Total central bank liquidity infusion is likely to peak out in Q2 and total close to zero for 2018.
Bullish on earnings, less on multiples:
MSCI earnings have been weak for the past few years which has now created a perception that India is relatively earnings underperformer. The streak of weak headline earnings may have ended already as the September quarter staged a significant recovery from Q1.
Higher oil prices and a favourable base means that earnings for Q3 and Q4 are also likely to be in double digits. Unless banks disappoint, the underlying strength in earnings is likely to show up in index earnings. Top down, BofAML expects 11 to 15% earnings per share (EPS) growth for MSCI India in FY18/FY19.
General Elections in 2019:
General elections in India are due in mid CY2019. However, electioneering is likely to begin well in advance. With seven state elections witnessing intense social media activity, general elections will be a very important drive for the incumbent government.
The current government is likely to consider some form of increased social expenditure ahead of 2019 elections. While many factors drive electoral victories, it is interesting to note that high fiscal deficit has generally coincided with the re-election of the incumbent government.
It is unclear whether a spending increase will happen in 2018; the BJP government may feel comfortable in its assessment of a victory without one, and may choose to be fiscally conservative.
IBC: The sale of assets
Proceedings under the Insolvency and Bankrupts Court (IBC) have gained momentum especially as the RBI recently encouraged banks to take large corporate accounts to resolution.
As many as 12 large accounts have already been admitted while another 40-50 accounts are reportedly due to admission now. The momentum is unlikely to abate as the focus of government on the resolution of bad debts with banks is likely to persist.
The recent announcement of the Rs2.1 trillion bank recapitalization plan creates room for the government-owned banks to absorb loan loss provisions on these assets.
GST: Moving from Mechanics to Economics
The Goods & Services Tax was implemented on July 1, 2017, but the GST in its fullest form is not yet rolled out. A majority of the country has been occupied with the mechanics of the GST which has been a challenge for many. The burden of getting the mechanics right has kept most businesses away from the big benefits of GST. The dynamics should change in 2018.
GST is likely to create earnings surprises in 2018 as companies begin to realize the efficiency benefits through lower cost and increase market share.
Housing for All:
The government of India has recently increased its focus on creating housing for the India population. As of November 2017, the total investment value of houses under the Pradhan Mantri Awas Yojna (urban) is Rs 1546 billion, up from Rs691 billion in October 2016.
Of this, the government has promised assistance of Rs444 billion of which Rs122 billion has already been released. 12,22,651 houses are currently under construction and 216435 have been completed.
Inflows into domestic Mutual Funds continue to remain strong since mid-2014. Domestic flows have contributed significantly to equity investments while foreign investments, on the other hand, remained volatile. Increasing return on equity in the US may shift the flow of funds.
Primary issuance in India too has been strong in 1HFY18. Further, equity issuance to the tune of $5 billion is expected in the near future. The supply of money will create demand and help in growing infrastructure.
The global investment bank argues for a net market downside in the year 2018, choosing stocks and sectors will be crucial. BofAML has slashed its overweight stance on financials, and increase in sectors like consumer discretionary, industrials, utilities, and materials.It has also increased its underweight on IT and telecom. BofAML turned underweight on healthcare sector as well.