Volatile Indian equity markets, flows capping downside: BofA on 2023

2023 could be another volatile year for Indian equity markets, according to BofA. In a report, the brokerage pointed out that the Nifty50, at present, is trading at 20.7x against its long-term average of 18.8x one-year forward earnings of current Nifty constituents. Plus, India is trading at a 98 per cent premium to its emerging market (EM) peers against its long-term average of 45 per cent.

" We can debate the quantum of it but markets are expensive whichever way we cut it. And that is one of the worries we have," said Amish Shah, head of research, India, BofA Securities.

Revival in China’s economic growth and policies could shrink this premium.

Moreover, there could be material downgrades to the consensus earnings estimates for financial year 2022-23 (FY23) and FY24, the brokerage said. External facing Nifty constituents, which constitute 21 per cent of the index, could lead to this fall, the brokerage said.

"The world is slowing down, there is a risk of recession. There is a perfect correlation between India's export growth and the US and Europe's economic growth. Recessionary events in the US have meaningfully impacted export growth for India.  Market upside will remain capped," Shah said.

However, the Indian equity markets are unlikely to fall much due to strong domestic flows.  Pension funds, insurance funds, and systematic investment plans (SIPs) could contribute at least $20 billion to Indian equities next year.

Though sustained foreign portfolio investor (FPI) outflows could incrementally put pressure on markets, the potential for incremental outflow is limited as FPI ownership is at a multi-year low. Moreover, household financial assets are witnessing a shift, with a higher proportion of savings allocated in favour of equities and small savings, a move away from deposits.

"FPIs will not do as much as they did in the last 12 months. Domestic investors will get at least $20 billion. On a net basis, the flows can continue to support. Markets are expensive and they will continue to be because of the flows,"  said Shah.

On whether China's easing opening up will eat into flows to India, Shah said India and China do not compete for EM allocation and they are directionally linked. FPI flows into the EM basket would imply inflows to India.

"More than 90 per cent of the funds that invest in India are non-India dedicated funds. They can under allocate to India or even decide not to allocate, but cannot withdraw money. It is very unlikely, "Shah said, adding, "Markets will not have outsized corrections. Someone will go buy the dip on the back of these flows."

Regarding sectors, Shah said financials, industrials, and metals could see upcycles as they are trading at or below average valuations. And IT, materials, energy, and consumer discretionary could either see a reversal in the cycle or are trading at expensive valuations.

On BofA's market outlook, Shah said it has a base case target of 19,500. And depending on how macro things play out, he expects Nifty to trade in the range of 17K-20K.