Will the Indian stock market continue to be "crazy" this year? Nomura: It's difficult!

In 2023, the Indian stock market will go on an unprecedented eight-year winning streak, with the SENSEX30 Index up 18.74% and the Nifty 50 up 19.42%. In terms of market capitalization, the Indian stock market has crossed the $4 trillion mark, and its total market capitalization has roughly tripled since its March 2020 low.

Will the "madness" in the Indian stock market continue in 2024?

On January 4, Nomura Bank analysts Saion Mukherjee and Amlan Jyoti Das noted in a report titled "India 2024" that the Indian equity market is expected to return 12% in 2024, setting a Nifty price target of 24,260 points by the end of 2024, while warning the market not to be overly optimistic:

We think the Indian equity market has a reasonable range of forward P/E ratios of 18-21x, implying returns between 0% and 17% in 2024.

Our base case is that global growth slows slightly, oil and commodity prices are within reasonable ranges, and the 2024 election outcome is favorable for India. In this scenario, we expect India's valuations to remain above historical levels due to stable macro fundamentals, strong corporate profitability and better liquidity support.

However, if commodity and oil prices rise and the election results are unfavourable, this will be a major structural risk for the Indian market. Globally, a non-landing (strong growth, stubborn inflation, and higher yields) and a hard landing (growth, inflation, a sharp decline in yields) could lead to higher risk premiums and lower valuations.

Nomura believes that the basic trend of the Indian economy in 2024 is expected to be a slight slowdown in both inflation and the economy, and the economic team predicts that GDP growth will slow from 6.7% to 5.6% in the 2024-2025 fiscal year, and India's GDP growth has so far been mainly driven by government and urban consumption. Rural and private capital spending has not yet begun to grow, and a global economic slowdown and macro uncertainty could have an impact on near-term growth.

Given that Indian stock market valuations are not cheap, Nomura believes that the current strategy remains somewhat defensive, and the current market expectations for the balance of growth and inflation in India are based on optimism, and any surprises could trigger the risk of high debt and fiscal deficits of the Indian government:

Sectors bullish include: financials (especially banking), healthcare, consumer goods, infrastructure, cement, power/coal, oil and gas, and telecommunications.

Sectors that are bearish include: Consumer Optional/Durable Goods, Capital Goods/Defense, Metals, Internet, and Information Technology. Neutral view on the automotive industry.

Optimism underpins Indian equities

Nomura noted that optimistic expectations for India's economic growth prospects and corporate earnings, the expansion of domestic market participants and the continued inflow of foreign capital, the central bank's interest rate cut, and the possibility of Modi's re-election have all contributed to investors' expectations for the Indian stock market to continue to rise.

According to Nomura, both domestic and foreign factors support the current valuation of the Indian market, with the Nifty Index trading at 19.9x one-year forward P/E, slightly higher than the average of 19.6x over the past three years. In the past three years (FY2021-2023), the market has traded between 17-23 times. This compares to the pre-pandemic (FY2017-2019) average of 17.7x, when the market was trading in a range of 16-19x:

Over the past three years, the spread between earnings yields and bond yields has fallen to the lower bound of -2.1%. In our view, deal valuations are above pre-pandemic levels in all sectors except banking and insurance.

From the perspective of the external environment, the market's basic assumption is that the U.S. economy has a soft landing, inflation continues to slow, and economic growth will also moderate to slow, which will help keep the equity market strong inflows. In the case of the S&P 500, the current P/E ratio of 19.7x is higher than the pre-pandemic average of 17.1x.

The spread between earnings yields and real bond yields narrowed by about 250 basis points, reaching its lowest level in the last 10 years.

Internally, India's stable macroeconomic environment and strong earnings expectations will drive equity gains. Oil prices are one of the key macro variables in India and have remained stable despite heightened geopolitical conflicts over the past few years. At the same time, strong domestic flows provide stability to the market, which lowers the beta factor.

As a result, in a more stable macro backdrop, Nomura expects the Nifty Index to return between 0%-17% over the next 12 months, with a relatively modest return in 2024 given strong returns in 2023, with a target level of 24,260 points and a potential return of 12%.

And if inflation becomes more stubborn, leading to a hard landing or no landing for the US economy in 2024, Nomura believes that the Indian stock market could fall by about 10% from current levels. In this case, this will be an entry opportunity.

India's economic growth is likely to slow in 2024, but the medium-term outlook is optimistic

In the report, Nomura discussed the different impacts on the economy under three scenarios: high inflation, moderate inflation, and a sharp slowdown in inflation. Overall, Nomura believes that the market currently expects the basic trend of the Indian economy in 2024 to be a slight slowdown in both inflation and the economy, and the economy is quite resilient in the narrative of strong capital spending and a relatively balanced trade market of imports and exports, and stock market valuations will remain high:

Since this is already considered in the stock price, we will choose according to the valuation of each sector. Our economic team's expectations are closer to this scenario, but there are some downside risks to growth.

Nomura expects India's GDP growth to slow to 5.6% from 6.7% in FY 2024-2025, compared to 6.7% in FY 2024. The global economic slowdown and macro uncertainty are likely to have an impact on India's economic growth:

Against the backdrop of global uncertainty, the transfer of the growth baton from the government to the private sector may be delayed. As the government lowers its fiscal deficit, government support for growth is likely to wane.

If the uncertainty over India's economic growth is resolved, the growth outlook will improve. We are positive on the medium-term growth outlook given the following factors: a) post-election policy continuity, b) low oil prices/commodity prices in the context of a global economic slowdown, which is good for maintaining a balance between imports and exports, c) strong corporate and bank balance sheets provide a solid basis for kick-starting the private capex cycle, and d) policy support for local manufacturing.

First of all, from the perspective of inflation, Nomura pointed out that inflation in India is mainly affected by supply shocks, and rising food prices will affect the overall inflation rate in the short term. According to Nomura, core inflation has largely stabilized, which allows the RBI to cut its policy rate from August 2024 in response to a slowdown in growth and in tandem with global rate cuts:

India's oil and commodity prices are not expected to rise further in the future, and the external balance of payments remains stable, with recent increases in services exports and remittances supporting the current account balance. In our view, a stable macro environment, moderately slowing economic growth, lower yields, and the inclusion of global bond indices bode well for portfolio flows in 2024.

From a consumption perspective, Nomura expects India's consumption growth to bottom out and begin to recover in the short term, with consumer sentiment returning to pre-pandemic levels:

In 2024, we expect consumption to be supported by falling inflation and interest rates, as evidenced by the Indian election. In 29 of the surveys over the past 60 months, rural wages have experienced negative growth. Recently, real wage growth has improved with the help of a decline in inflation.

Under the influence of the Rural Employment Security Law, the demand for rural employment has declined and the employment situation has improved. Consumption in cities is relatively stable, and wages are growing rapidly, especially in the service sector. This trend is reversing to some extent as hiring momentum slows.

Maintain a cautious strategy

Nomura pointed out that the market started 2024 with considerable optimism, but the downside risks of weak growth and stubborn inflation should not be ignored, and at the same time, the Indian market has anticipated the outcome of the 2024 election in advance.

As in the past two years, market expectations often swing from side to side, and investors must be nimble in responding to changing markets.

From a macro perspective, we prefer a slowdown in global growth and central banks will take immediate action on inflation, but if inflation rebounds more than expected, coupled with higher neutral rates, there will continue to be fears of a hard landing.

And this situation will adversely affect India's imports and exports. We expect high inflation to adversely affect consumption, and continued uncertainty about economic growth to dampen capital spending. This could keep India's future growth sluggish.

In the medium term, the profitability of Indian businesses is expected to increase as a percentage of the country's GDP.

As a result, Nomura pointed out that their sector selection for Indian equities is biased towards relatively moderately valued stocks, with a defensive layout:

Overweight (OW) on the following sectors/sectors: Financials (particularly Banking, Consumer Staples/FMCG (Fast Moving Consumer), Infrastructure, Cement, Oil & Gas, Healthcare, Telecoms, Power/Coal.

Underweight (UW) on the following sectors/sectors: Consumer Discretionary/Consumer Durables, Capital Goods/Defence, IT Services, Internet, Metals.

Banking: After a cyclical upswing, it is expected to become more stable next

Nomura expects India's banking sector to be in a strong cycle for the third consecutive year in 2024, but with relatively modest gains in this year:

Loan growth in the banking sector has slowed, with loan growth reaching 16% year-on-year as of mid-December 2023 and falling to 13-14% in fiscal 2024-2025. While net interest margin (NIM) bottomed out at the end of FY2024, the base effect will lead to modest year-on-year net interest income (NII) growth, resulting in a moderate core pre-operating profit (PPOP) growth path for large banks through the first half of FY2025 and then picking up again.

While there may be some volatility or challenges in the near term, in the longer term, we expect the banking sector to continue to experience strong credit demand growth and achieve higher returns on equity. The Nifty Bank Index (up 12% in 2023) underperformed the Nifty Index (up 20% in 2023), partly reflecting the still-dovish cyclical momentum.

Non-bank financial institutions: Growth is at risk, and the outlook for mid-cap/small-cap institutions is expected to be poor

Nomura said he remains cautious about the growth prospects of non-bank financial institutions (NBFCs), especially small/mid-sized NBFCs that are highly reliant on unsecured loans:

Looking ahead, we expect the RBI to increase its risk weight on unsecured loans to curb excessive risk accumulation, which will prompt non-bank financial companies (NBFCs) that are highly reliant on this sector to opt for one of two strategies:

1) higher yields to protect profitability, which could negatively impact loan demand/growth;

2) Sacrificing profitability to keep loan demand/growth and yields constant.

In addition, in other secured areas, we expect small/mid-sized NBFCs to continue to face stiff competition from large NBFCs and banks.

Insurance: Regulation has become the focus of industry development

Nomura pointed out that increasing the surrender amount in an insurance policy (i.e., the amount that policyholders can receive when they surrender) is bad for the industry, but the industry's overall low valuation limits downside risks:

The draft published by the Insurance Regulatory and Development Authority of India (IRDAI) in December 2023 proposes to increase the surrender value of non-linked products that are not directly related to market investments, which we believe is detrimental to the industry from a VNB margin perspective.

According to the calculations of the draft, increasing the surrender value to more than 75% in the first few years, which is currently 0%-50%, will have a negative impact on the profitability of some of the insurer's products.

While the exact impact of these new drafts is currently unclear, IRDAI has asked insurers to submit comments on the drafts by January 3, 2024. We believe that discussions and the eventual implementation of the new regulations will take time, so there may be uncertainty for the insurance industry during this period.

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