Global brokerage major BofA predicts that the risks to earnings growth, which include the impact of the global economic slowdown, specifically on the IT sector, as well as potential delays in rural revival and the possibility of a peak in urban demand, are apparent in the market movements.
These factors may cause further reductions to the consensus estimates for Nifty's earnings growth for FY24/25 from 17 percent/16 percent now by up to 40 percent, it says.
BofA expects flattish returns for 2023 and has kept its Nifty target unchanged at 18,000. Investors should consider taking profits, it suggests. BofA, however, recommends buying on potential market dips, particularly if the Nifty falls to 16,000 - an 11 percent decrease - due to strong domestic investments, unfavorable FII positioning, and India's robust macroeconomic performance.
The brokerage says IT remains at the top of its underweight list. It stays underweight on staples, discretionary and telecom sectors, too, and continues to favour financial, industrials, cement, steel and select auto (two wheelers), utilities and healthcare as defensive plays. BofA remains normal weight on the energy sector.
Nifty valuations are expensive, BofA says, with a one-year forward P/E of 19.5x. The brokerage house says that once Nifty FY24/25 earnings growth normalises to 11 percent/9 percent, the valuations will seem even more expensive, compared to other emerging markets and debt.
The recent decline in First Republic Bank, coupled with the looming debt ceiling deadline in June, credit tightening, and the weakness in commercial real estate, could be the early signs of an impending recession in the US. Based on BofA's analysis of the past two recessions in 2001 and 2007, the S&P 500 could potentially drop by 20-40 percent after the recession kicks in. While the Nifty usually mirrors the S&P, it tends to experience less severe declines historically.
During a recession, tightening credit and easing liquidity typically result in the worst phase for stocks. If the US slips into a recession, India's GDP growth may contract by 190bps based on past instances, with export growth declining sharply from double digits to low single digits, according to a BofA report.
If the Fed fails to meet the market's expectations of a rate cut in September, it could cause a drag on the markets in the second half this year. BofA expects the rate cut next March.
During a US recession, India experiences a less protracted economic growth contraction for one to three quarters, compared to two to seven quarters for the US, and it also recovers faster in two to three quarters as against the three to eight quarters the American economy takes to heal.
Indian markets too tend to deliver higher returns than the US in the 12 months after a US recession. The report predicts that domestic passive flows will remain strong with estimated flows of over $20 billion from EPFO, NPS, ULIPs, and SIPs, with large-cap stocks accounting for about 75 percent of these flows. The report also suggests that investors should switch from large-cap stocks to mid/small-cap stocks.
BofA notes that selling by foreign institutional investor (FII) will moderate because of low FII positioning in India and its strong macroeconomic fundamentals. India's overweight position in EM funds hit a multi-year low of 0.21 percent in March 2023, compared to 1.2 percent in January 2015, and FII ownership of the NSE500 Index declined to 19.2 percent in March 2023 from 23 percent in December 2019, it says.
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