What BofAML Suggests Buying in Asia's Costliest Stock Market

(Bloomberg) -- Want to buy shares in Asia’s most-expensive stock market? Stay with high-quality companies that better weather downturns and perform respectably on the way up.

That’s the advice from Bank of America Merrill Lynch after Indian equities posted multiple records this year, fueled by a tide of liquidity and optimism about the government policy. The euphoria has had the usual side effect: stocks have become expensive. The S&P BSE Sensex’s estimated price-earnings ratio has reached 22, the steepest among equity benchmarks in the region. A measure of smaller companies is even costlier.

“It is better to stick with companies that are delivering consistently, where the earnings outlook for the next three to four quarters does not lie in a wide range,” Sanjay Mookim, BofAML’s India equity strategist, said in an interview in Mumbai. “We advise clients that the operative philosophy in Indian equities is to avoid risk.”

Mookim was the best Sensex forecaster last year among leading overseas brokerages tracked by Bloomberg. The index ended 2016 just 2.4 percent above his year-end target of 26,000. It closed at 33,314.56 Friday.

Sentiment has shifted toward companies with the reliable record of profits and sales growth, with Maruti Suzuki India Ltd., Hindustan Unilever Ltd. and HDFC Bank Ltd. being among the best performers on the Sensex in 2017. At the other end are drugmakers, the once favorite growth stories are now facing lower prices for generics in the U.S.

Stocks fitting into higher-quality buckets -- retail banks, auto- and auto-parts makers and consumer companies -- are few and pricey, Mookim said. Even so, investors must seek firms with robust earnings and avoid companies where the market is only “pricing in hopes of significant change,” he said.

“There’s a very narrow portion of the market that is steadily delivering and is expensive, but that’s my recommendation: boring portfolios, safe portfolios because valuations risks are high,” Mookim said.

Here are the highlights from his interview:

What can trigger a correction in Indian stock prices?

• “The market is not being driven by the Indian macro trends but is moving along with the global liquidity tide. Risks to Indian equity valuations therefore can also emerge externally. 
• “It is difficult to precisely anticipate the cause of a global equities correction. Maybe it is a slowdown in China or the U.S. Fed rate increase or perhaps issues with banks in Europe. 
• “While we are hopeful the Indian economy will recover, the equity market is driven by different factors entirely.

What is your outlook on India’s economy?

• “The economy is going through a cyclical slowdown, and has been buffeted by large policy changes. This will predictably improve. Very little capacity is being added in aggregate, while demand is growing steadily. 
• “Industrial utilization will improve with time, driving a cyclical upside. This will be buttressed by the positive effects of major reforms that have recently been instituted.

Are strong domestic flows keeping valuations elevated?

• “Local equity inflows were not met with a corresponding supply of issuance for quite a while. That drove up valuations of mid- and small-cap stocks.
• “Now, we have started to see significant equity issuance. As issuances absorb inflows, there should be no net impact on valuations. 
• “Valuations in themselves have never been a good predictor of a correction. They can stay elevated for long periods of time. They are indicators of risk.
• “We will be lucky if valuations reduce through a time-correction. A jolt or a price fall is more likely.”

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