BNP Paribas is cautious on Indian equity markets, but bullish on these three sectors

The abrupt fall of more than 2,000 points in the BSE Sensex over a mere three sessions has once again ignited discussions about the factors influencing market valuations. In this backdrop, a report by BNP Paribas highlights that the gap between bond yields and earnings yields has crossed 2.1 per cent, which is an indicator for the foreign firm to turn cautious. Bond yields and earnings yields popularly known as bond-earnings yield ratio or BEER ratio suggests the attractiveness of equities against bonds. The ratio is calculated by dividing the bond yield by the earnings yield of the stock market.

BNP Paribas highlighted that forward returns have been weak when bond yields have exceeded NTM (next 12 months) earnings yields by 2 percentage points. “We have seen this in 2010, 2014 and 2018. However, 2022 was an exception with healthy returns despite an elevated gap. We turned positive on the market in March 2023 when the bond-earnings yield gap narrowed to 1.5 per cent. However, the subsequent rally in the market has resulted in the gap crossing 2.1 per cent, which to us is an indicator to turn cautious,” BNP Paribas said.

It further highlighted that most sectors in India are currently trading at a premium to their respective last-decade averages (in terms of NTM P/E multiples). “Exceptions are banks and sectors dominated by public sector enterprises. Several sectors are also trading at 2-3 times the multiples prevailing a decade back. This has reduced the margin of safety,” BNP Paribas said.

The global firm continues to prefer financial services, information technology and telecom sector, while it have added logistics in the outperformance space. On the other hand, BNP Paribas expects consumer staples, pharma and autos, to underperform given their rich valuations.

In the banking space, HDFC Bank, ICICI Bank and Axis Bank are BNP Paribas top three large-cap ideas in order of preference. It also prefers AU Small Finance Bank in the midcap space.

Sharing its view on IT sector, BNP Paribas said, “With easing inflation and the Fed’s indication of rate cuts, we see discretionary IT spends likely resuming in 2024, which should accelerate revenue growth for Indian IT services companies. Moreover, the recent positive tilt in commentary from the top four companies provides comfort.”

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