Nifty's 2024 Performance Hinges On Lok Sabha Election, Bond Yields: CLSA

The performance of Nifty would be dependent on the outcome of the Lok Sabha election and trends in bond yields, according to CLSA.

Even after two years of de-rating in multiples, CLSA said it cannot rule out further gradual de-rating in the NSE Nifty 50 in 2024 before valuation froth ends as earnings growth catches up.

A significant factor preventing this could be a sharp cool-off in bond yields, especially if the U.S. Federal Reserve shifts away from its higher-for-longer stance, the brokerage said in a note on Tuesday.

The national elections in India and a potential pickup in Chinese growth are expected to play crucial roles in shaping market dynamics in 2024, CLSA said.

In the Indian market, the differential between the 10-year government securities yield and the 12-month forward Nifty earnings yield stands at 1.96 percentage points. This is dangerously close to the threshold of 2.0 percentage points, which has historically signalled a top, according to CLSA.

Indian equity valuations have very limited room to rise unless there is a fall in risk-free rates or bond yields, the brokerage said. "This extended valuation has seen two years of de-rating in India as Nifty has risen by only 14% in the past two years when EPS growth has been a much stronger 25%, which implies a 11% decline in PE."

CLSA underscored that using the 10-year G-sec flat at 7.25%, the base case valuation of Nifty at the end of December 2024 would be 18,730, suggesting a 5% downside. The upside in the bull case should be 13%, despite the 15% year-on-year growth expected by consensus in Nifty's fiscal 2025 earnings per share.

"On the other hand, a cool-off in Indian 10-year G-sec yield to 6.5% will take up the base/bull case upside to 8%/31%," it said.

CLSA said it is encouraging to note that the current differential between the US and Indian 10-year yields, when compared to forward-market rupee-depreciation expectations, suggests room for a 50-basis-point cool-off in Indian yields even under the current setup.

The continuity of the current Bharatiya Janata Party-led regime, especially with a near-majority seat share, is likely to be perceived as the best-case outcome by the Indian markets, according to CLSA.

This outcome could contribute to tailwinds in investment themes related to infrastructure, new energy initiatives, Make in India and other related sectors, it said. "While we sense low investor confidence in Chinese growth, any surprises here could push foreign flows away from the more-expensive Indian market in 2024."

Following a cool-off in inflation in the U.S. in the past few months, the consensus is that the Fed is done with hikes. Expectations predict 50–75 basis points of rate cuts in 2024, it said.

These expectations underscore a high level of confidence in a soft landing as well as a hope that the Fed will soften its strong narrative to keep rates higher for longer, it said. "The price action in 2024 will perhaps be most influenced by which way this turns."

CLSA pointed out that it remains to be seen how emerging markets' central bankers, including the Reserve Bank of India, will act during potentially long pauses by the Fed.

CLSA India economist Indranil Sengupta expects the RBI to start cutting rates very soon. "However, it is possible that the government may not take any risks on inflation before elections in mid-2024."

CLSA expects 2024 to be another year of low returns for Indian equities when Nifty returns lag earnings-per-share growth as well as the cost of equity. "This expectation of low returns is also the reason why our CLSA India portfolio is heavy on mega-caps where we see a good risk-reward."

CLSA's portfolio is overweight on banks, insurance and energy. The huge outperformance of small and mid-caps over large caps has taken their relative valuations to much above comfort levels, and we recommend investors be very selective in this space.