Bank of America's Amish Shah Warns of Small and Midcap Stock Overvaluation

Amish Shah, Head of India Research at Bank of America Securities, maintains a cautious stance on the market, forecasting that the Nifty will yield only single-digit returns in 2025—comparable to fixed-income investments. He remains particularly skeptical about the broader market, emphasizing that despite recent corrections, mid and small-cap stocks are still overvalued. Shah anticipates the potential for further declines in this segment, with returns possibly underperforming or even turning negative relative to large-cap stocks.

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The growing concern among market analysts regarding mid-cap stocks and small-cap stocks stems from their performance in recent months. After experiencing a strong bull run over the past two years, these segments have faced intermittent slowdowns over the last six months.

The downturn in small and midcaps has been especially pronounced in the last two months, with both indices plunging over 20% from their record highs, officially entering bear market territory.

Many experts, including Shah, attribute expectations of subdued returns to India's valuation challenges. Speaking to CNBC-TV18, he noted, "India is currently in a cyclical downcycle or a phase of growth moderation. This makes it difficult to justify valuations above long-term averages, even after recent corrections."

Despite the latest market pullback, Shah highlighted that the Nifty still trades at a 4% premium over its long-term average. "Ideally, this premium should shrink to zero. So, from a valuation standpoint, there is a potential downside of 4%. With earnings expected to compound at 10-12% this year, we arrive at our single-digit return projection," he explained.

Reinforcing his cautious perspective, Shah pointed out that Foreign Institutional Investor (FII) inflows are likely to remain weak. "With the US 10-year bond yield around 4.5-4.6%, the hurdle rate for emerging markets like India is roughly 15%," he stated. Given that the broader Indian market is unlikely to generate 15% returns, he believes FIIs will favor US treasuries or equities over Indian assets.

Sector-Specific Outlook

In August, BoFA Securities downgraded 13 of the 14 industrial stocks it covers, shifting them from 'buy' to 'sell'. Despite the recent correction, the firm has since upgraded only one stock to 'neutral,' leaving the sector with one 'buy,' one 'neutral,' and 12 'sell' ratings.

Even after six months, Shah remains bearish on the sector, expecting further declines. He explained that during the capex upcycle from FY21 to FY24, industrial companies experienced a 20% increase in order flows, which fueled 20–30% earnings growth as margins and working capital cycles improved.

Now, with capex growth slowing to 13%, earnings growth is expected to decline to mid-teen levels, necessitating both earnings revisions and valuation corrections. "While a significant portion of the correction has occurred, we are not there yet. We continue to have a negative outlook on capex-related sectors such as cement, steel, energy, and power utilities," he added.

On the other hand, Shah is optimistic about rate-sensitive sectors, including autos, real estate, select internet companies, and some financials. "Given our cautious market stance, we also maintain defensive positions in healthcare and telecom," he noted.

Among these, he is particularly bullish on healthcare due to its defensive nature. "Demand remains inelastic, supply chains are difficult to relocate, and valuations are not excessive. We see both cyclical and structural opportunities—generics and hospitals, respectively—making healthcare an overweight sector in our portfolio," he explained.

Additionally, Shah is selectively positive on jewelry, travel and tourism, and cigarettes, along with a few staple consumer brands. However, he remains unconvinced about the broader consumption sector.

While the government's $12 billion (₹1 lakh crore) tax stimulus is a welcome boost, it equates to just 30 basis points of GDP and less than 1% of India’s retail market. "So, while it provides some support, it won’t be enough to drive broad-based growth," he concluded.