Bank of America Securities (BofA) sees the Indian benchmark index Nifty50 rising to 20,500 levels by December 2023, indicating an almost 5 percent upside potential from 19,570.85, as on August 8. The brokerage has also increased the Nifty target from 18,000 forecasted in May 2023.
The rise in the target comes on the back of expectations of “mild to no recession” in the US, said the brokerage. “If the US averts a recession, we will see bulls take a firmer grip on the markets as their key concern (recession) will be addressed and will support a continued valuation expansion,” it explained.
Earlier this month, the brokerage also revised its outlook for the US economy in favour of a 'soft landing'.
“By December 2023, we expect Nifty to gain further to 20,500, as: a) historically, Nifty’s returns have mostly been positive at least three months prior to the end of the US recession as well as during the phase of US Fed’s penultimate rate hike to six months after the start of rate cuts (current phase); b) domestic inflows could continue to be robust; and c) a third of Nifty market cap still below long-term average valuations, a few of which offers buying opportunity,” explained BofA.
It further highlighted that with one of the key risks of a US/global recession now out of the way, there is potential for Nifty's valuations to re-rate.
Historically, Nifty's returns have mostly been positive at least three months prior to the end of the US recession as well as during the phase of the Fed's penultimate rate hike to six months after the start of rate cuts (current phase), the brokerage pointed out.
However, BofA still believes that the markets could drag in the near term given the recent spike in crude, inflation spike led by erratic rains, and commodities rally on potential China stimulus. Also, the busy election calendar over the next few months that ends with the general elections in 2024 is another risk factor to watch, it added.
"The impact of these factors may be transient/not significant. We, hence, advise buying any potential dips. Even if China's stimulus does lead to FII outflows for India in the near term, this trend reverses on a yearly basis. Besides, our analysis suggests contraction in Nifty’s valuations could see significant active inflows for domestic institutional investors (DIIs), limiting the downside," stated the brokerage.
The brokerage prefers largecaps over their mid-and small-cap peers (SMID) as the valuations in the case of the latter (SMIC) are rich and earnings growth estimates seem stretched.
It further noted the market cap of a third of the Nifty's components is still below long-term average valuations and a few of those are still buying opportunities.
Among sectors, the brokerage suggests avoiding ones with a high risk of earnings downgrades, growth mainly driven by margin expansion (risk from commodities’ spike), or the ones that saw recent rally mostly led by valuations expansion versus earnings. It is cautious on BofA is cautious about IT, certain parts of the auto and discretionary sectors, metals, cement, telecom, utilities, and materials.
Meanwhile, BofA remains overweight on financials due to attractive valuations and limited earnings risks and industrials due to strong capital expenditure and real estate trends.
In the automobile sector, passenger and commercial vehicles are projected to grow and also improve margins. Healthcare remains promising due to favourable pricing in the US and robust specialty business in India, said the brokerage.
It has also upgraded staples to ‘overweight’ on rural recovery indicators, shifted consumer discretionary to ‘neutral’ and downgraded cement and utilities to ‘underweight’ due to potential earnings risks from costs and regulations.
BofA continues to see risks to Nifty’s earnings growth (BofAe FY24/25: 13/11 percent versus street estimates at 17 percent).
For the upcoming RBI monetary policy due tomorrow, the brokerage house expects the MPC (monetary policy committee) to deliver a hawkish hold while retaining the stance as “withdrawal of accommodation”. It does see the recent tomato price spike to push the MPC to hike rates right away, according to such episodes in the past. However, it predicts one more 25 bps hike in CY23 as CPI inflation is still away from the 4 percent target.
The brokerage noted that between June 1st and now, the retail price of tomatoes has shot up 5x. Accordingly, the Jul CPI inflation rose to 6.6 percent YoY, breaching the upper limit of MPC's tolerance band. Thus, concerns surrounding their stance and action on Aug 10th have resurfaced.
"We looked at RBI's policy response to such episodes in the past and conclude that the RBI MPC would likely deliver a hawkish hold this time and retain the stance as withdrawal of accommodation. That said, we are looking at another 25bp repo rate hike in the remainder of CY23 as the 4 percent CPI inflation target is still elusive and agree that the inflation battle is only half won. So, it's not the fleeting tomato price spike that may result in another hike but the protracted journey to the target," it said.