BofA Cuts Nifty Target To 14,500, Has A Defensive Sectoral Skew
BofA Securities is cautious on Indian markets as it trimmed its Nifty year-end target to 14,500 points amid persisting macro headwinds.
The financial services firm said it maintains a "cautious stance with defensive sectoral skew" and revised its outlook downward from 16,000 earlier.
In addition to globally tightening monetary conditions and a slowing economic outlook including fears of a recession in the U.S., it sees other risks:
Likely earnings cut for Niſty in Q2/Q3FY23 as effects of cheaper inventory buffers fade.
Headwinds from higher crude likely sustaining.
Niſty valuation, though corrected, still appears vulnerable close to its 10-year average.
BofA listed five reasons on why it is cautious:
Fast tightening monetary conditions: The U.S. Fed has hiked rates by 150 basis points since March and the research firm's economists see another 125b basis points by September. 26 out of 34 global central banks are in tightening mode and this will increase once the ECB starts to hike. Tightening liquidity is negative for equity markets. Estimated $3.2 trillion contraction in G4 balance sheets by December 2023 is expected to drive equity underperformance.
Fears of recession: BofA economists recently slashed the CY22 global GDP growth forecast by 100 basis points to 3.2%, with risks firmly skewed to the downside.
Earnings cuts: BofA estimates remain 4% lower than consensus estimates for Nifty earnings for FY23/24 with scope for further downgrade. 15% earnings growth could seem reasonable versus consensus estimates of 24%/15% growth, respectively for FY23/24.
Crude: Brent crude has averaged $104 a barrel year-to-date and BofA's commodities team sees no relief in the near term, with forecast of $105 a barrel in the second half of 2022.
Valuations: While Nifty now trades at 17 times the one-year forward consensus EPS, which is close to its 10-year average, it could see further contraction led by earnings cuts and slowing global growth. U.S. potentially slipping into a recession is a key downside risk and could act as a negative trigger.
If the negative events are likely to play out in the next two to three months, BofA sees the Indian markets bottoming out as soon as August or September this year.
Could Domestic Flows Withstand Macro Headwinds?
Aided by strong domestic investor inflows, Indian equities have managed to outperform, with Nifty down 11% year-to-date versus a 23% fall in S&P 500.
"Key investor concern is hence potential for a sharp correction of Indian markets if domestic equity inflows reverse, led by rising yields (debt/bonds could pose as an alternative investment option) or market correction-led redemptions," it said.
However, BofA's analysis since 2000 suggests:
Only a small negative correlation (-11%) between domestic equity outflows and debt inflows.
Overlap of equity outflows and debt inflows is seen for only 23%/29% of monthly instances even when 10-year government security yields were as high as >8%/>9%.
Given BofA estimates for 10-year government security yields are lesser than 7.6% till Q1 of 2023, sustained domestic equity inflows could hence be an upside risk to its current cautious thesis.
BofA Securities maintains a defensive strategy skew.
It raised its 'overweight' stance on staples, healthcare, and utilities. Moved energy to 'overweight' from 'underweight' on persistent high energy prices.
Remained 'overweight' on select domestic cyclicals such as industrials, financials, and autos.
Marginally trimmed 'overweight' skew on financials, given that while sector earnings visibility remains strong, bank index exhibits strong correlation with U.S. bank index performance and could see some headwinds from negative sentiments on fears of a U.S. recession.
Sees limited risks for the capex upcycle on strong government intentions and limited historical inverse co-relation with rates cycle.
Maintained 'neutral' on I.T. (strong earnings/dollar tailwinds, though valuation risks)
'Underweight' on communication services (5G auction overhang), high beta discretionary (growth slowdown/ valuation concerns) and materials (de-rating on pricing pullbacks).