Nuvama has emphasised the historical impact of the narrowing US Current Account Deficit (CAD) on earnings, noting that in years such as 2008, 2011, and 2019, earnings were adversely affected, and the market sentiment faltered.
The domestic brokerage firm highlighted how domestic cyclicals like automobiles, industrials, and BFSI sectors were significantly impacted. Markets only recovered when 10-year yields decreased by over 150 basis points and valuations became more attractive, it noted.
In the current fiscal year, valuations remain high, and yields are elevated despite rate cuts, with domestic easing insufficient to counteract the global economic drag. Nuvama has decided to downgrade the BFSI sector to ‘Underweight’ (UW) due to increasing MSME stress and the deflationary environment. On the other hand, the IT sector has been upgraded to ‘Overweight’ (OW) owing to its low relative valuation and the earnings gap.
“The impact of narrowing US goods trade deficit could be higher this time around. This is because, post-covid, it is US consumers (backed by fiscal firepower) that have single-handedly buoyed the US economy. China, the second-largest economy after US, struggled with domestic deflation in the wake of its RE meltdown, spurring dumping of excess capacity on the world. Most of it was absorbed by the US. Now, with the US trade deficit likely to narrow, who will absorb China’s excess capacity?,” Nuvama said.
During the past episodes of narrowing of US trade deficit-2008, 2010-12 and 2018-19, there was a sharp slowdown in aggregate earnings growth. The slowdownwas not just restricted to exporters and commodities, but even domestic credit growth slowed.
“Furthermore, even about profits, those of BSE500 (ex-BFSI, exporters and commodities) slowed sharply despite their ‘supposedly domestic demand dependent’ tag, with little to differentiate between their growth and that of exporters. In the end of 2019, they marginally outperformed but that’s primarily owing to tax cuts,” Nuvama said.
The equity market has been predominantly driven by domestic factors over the past three years. However, Nuvama predicts that the global outlook will now heavily influence earnings, particularly with stabilising profit margins and persistently weak domestic demand. Export demand, which affects two-thirds of the top line, will be a critical determinant of future earnings, according to Nuvama.
Nuvama further stated, “Furthermore, on the flows front, FIIs have become the marginal price setter as DII flows are being offset by large equity supply. ‘Global’ is, thus, the focal point.” This highlights the significant role of global factors in shaping market sentiment and earnings forecasts.
The research also indicates that tariffs will have a broad negative impact, especially on domestic cyclicals, due to the narrowing of the US CAD, which presents a global deflationary challenge. High profit margins in domestic sectors, coupled with weak demand, pose risks of operational deleverage. While domestic easing has commenced, deeper global economic pressures require further earnings cuts.
The dollar weakness following tariff announcements initiated a rally in emerging markets (EM), although valuations are now considered expensive. The Federal Reserve’s future actions, particularly regarding rate cuts, will dictate EM flows. Historically, markets only stabilised after equity corrections made valuations more appealing and the US 10-year yield fell by 150-200 basis points, Nuvama said.
With regard to portfolio strategy, Nuvama recommends maintaining a defensive bias and preferring large-cap stocks over small and mid-cap stocks (SMIDs). The firm has downgraded BFSI to underweight (UW), citing concerns over asset quality and the global deflationary environment. Nonetheless, it maintains a favourable view on the top two private banks and insurance within BFSI. IT has been upgraded to OW due to compressed valuations despite maintaining earnings differentials.
Additionally, reliance on OW status has been upgraded due to its value unlocking potential. Other sectors rated overweight (OW) include consumer, telecom, internet, cement, IT, pharma, and chemicals, while BFSI, industrials, power, and autos remain underweight. This strategic pivot reflects Nuvama’s focus on macroeconomic factors rather than individual stock performance.