Further valuation expansion unlikely: BofA Securities' Amish Shah

Broader markets represented by small and midcap stocks are trading at even higher valuations or close to two standard deviations over long-term averages, Shah said

The markets are trading above their long-term averages and further expansion in valuation is unlikely, says Amish Shah, Head of India Research, BofA Securities. In an interview with Samie Modak in Mumbai, Shah says recovery in GDP, capex, and consumption revival could fall short of consensus expectations. Edited excerpts:

 

The markets are now less than 3 per cent away from fresh record highs. What has underpinned the latest rebound in equities?

 

We believe this rally has been underpinned by four key positives. These are the recent cuts in policy rates as well as the cash ratio reserve (CRR) by the Reserve Bank of India (RBI), a weaker US dollar, expectations of an imminent US-India trade deal and better-than-expected fourth (Q4FY25) results. On the back of these factors, the markets are expecting a continued recovery in economic growth as well as corporate earnings growth this financial year.

 

Have valuations become uncomfortable at this juncture?

 

In March 2025, we turned positive on the market arguing for a higher than long-term average multiple on the back of our expectations of positives highlighted. The Nifty is currently trading at 22x one-year forward P/E ratio or at one standard deviation higher than its long-term averages. We believe a further valuation expansion is unlikely. 

 

Broader markets represented by small and midcap stocks are trading at even higher valuations or close to two standard deviations over long-term averages. And, about a 50 per cent valuation premium to largecaps. The small and midcap rally is driven by valuation expansion, which may be tough to sustain. 

 

What’s the upside one can expect over the next one year?

 

We retain our calendar 2025 Nifty target at 25,000, implying no further returns from the current levels. We, hence, believe small and midcap stocks are now overpriced.

 

Any specific headwinds one should be mindful of?

 

We foresee some key headwinds for markets. Earnings growth is likely to recover modestly, but consensus estimates may face further downgrades. While monetary stimulus should support India’s GDP, capex, and consumption revival, the recovery may fall short of consensus expectations. For instance, the Nifty earnings growth is expected to reach 9 per cent in FY26, an improvement from FY25’s 6 per cent but below the consensus forecast of 13 per cent. Markets appear to be fully pricing in an imminent India-US trade deal, making any delay or disappointment a significant risk. Additionally, markets are not factoring in risks from a potential global or US economic slowdown amid ongoing trade tensions. With a 96 per cent correlation between the Nifty and S&P 500, any S&P correction could impact Indian markets.

 

Which are the sectors you are bullish and bearish on?

 

We prefer rate-sensitive domestic cyclical sectors such as financials, real estate investment trusts (REITs), real estate and autos. We also prefer defensives such as domestic healthcare, hospitals and telecom, given our cautious views on markets.

 

On the other hand, we are cautious on sectors exposed to the international markets such as IT, energy and steel. This is followed by those exposed to capex-related ones such as industrials, cement and staples as we expect a shallow consumption revival. 

 

Foreign flows into India have been muted lately and over the longer term. Why so?

 

Over the past five and a half years, foreign portfolio investor (FPI) inflows into India have been modest at $20 billion and highly volatile. There was $16 billion in outflows in calendar 2022 followed by $21 billion in inflows in 2023. In 2025, after $13.5 billion in outflows from January to March, FPI inflows rebounded to $3.2 billion in April–June, driven by a weaker dollar and India’s attractive relative market returns. However, following the recent market rally, the risk-reward profile appears unfavourable, and we expect incremental FPI flows to remain muted at best.

 

Are strong domestic flows cushioning the market falls?

 

Mutual funds have experienced over $220 billion in cumulative inflows, significantly outpacing FPI flows, which have amounted to just $20 billion over the same period (five and half years). We anticipate that domestic investors will continue to be a major force in the Indian markets. Additionally, changes in investment mandates for endowment funds since 2016 have ensured a steady flow of investments into equities. Moreover, current tax laws favour equities over debt, and with lower bond yields, domestic retail investors have increasingly favoured equities. However, given the current rich valuations, we believe that domestic flows could become more volatile compared to the steady expansion observed over the past five years. This trend is already beginning to play out.

 

What’s the impact of large block deals and initial public offerings (IPOs) on the secondary market?

 

Large primary and secondary deals have the potential to absorb a significant portion of domestic flows, thereby keeping valuations and markets in check. As a result, we expect the Nifty to trade sideways for the remainder of 2025 until a meaningful earnings upgrade cycle returns.