In an exclusive chat with ET Markets, Amish Shah, Head of India Research at BofA Global Research, said valuations in the sector now reflect most of the positives that drove the sharp rally over the past year, making risk-reward “more balanced” and prompting his team to book gains.
“We have tweaked our stance on the defence sector post the Budget. Over the past year, we maintained a constructive stance, supported by tailwinds from heightened geopolitical uncertainty, accelerated emergency procurements under Project Sindoor and a robust around 17% YoY increase in defence capital outlay. These drivers have delivered strong order flow growth for companies within the sector and a sharp stock and sector rally,” Shah said in an interview.
“However, with valuations now reflecting most of these positives, we believe risk-reward has turned more balanced. Accordingly, we would look to book profits,” he added. In the last one year, the Nifty India Defence index has outperformed with a 28% rally and has nearly doubled in value in the last two years.
Budget 2026 saw a 21.8% increase in defence capex, but the core capital outlay, which excludes spending on land, construction infrastructure and R&D, rose 17% to Rs 1.8 lakh crore.
The Ministry of Defence has earmarked 75% of the capital acquisition budget for procurement through domestic industries during FY26-27, underscoring the government’s push for indigenous manufacturing. Yet Shah’s call to exit suggests the Street is turning cautious on stretched valuations despite the sector’s strong fundamental backdrop.
Shah is rotating into rate-sensitive cyclicals instead. “Overall, we prefer rate sensitive cyclicals. On the consumption side, we expect the well-off consumer basket would continue to outperform the mass consumer basket. Among globally exposed sectors, we prefer pharma and non-ferrous metals, while we remain underweight on IT, steel and energy. Within defensives, we continue to favour telecom and hospitals, which offer steady earnings visibility and low volatility,” he said.Also Read | Defence stocks face test of nerves as 22% capex lift in Union Budget meets lofty valuations
Nifty target at 29,000 by December 2026
On the broader market outlook following the US-India trade deal announcement, Shah struck an optimistic tone. “Our target for Nifty is 29,000 by the end of this calendar, offering about 13% upside. The US-India trade deal with tariffs at 18% is in line with our expectation of 15-20% tariffs. Conclusion of the US trade deal would provide clarity and alleviate downside risks,” he said.
“While details of the deal are still awaited, the trade deal confirmation is sentimentally positive for markets, as it reduces policy uncertainty and de-risks the external trade environment,” Shah added.
He identified export-oriented sectors as key beneficiaries. “Export-oriented sectors with high US exposure would be key beneficiaries, including textiles, cables and ports and logistics service providers.”
However, Shah cautioned that while the headline is directionally positive, the fine print will determine the extent of benefits across sectors.
Will FIIs return after trade deal?
While the trade deal removed a key overhang for foreign institutional investors, Shah said it was not the only barrier to sustained inflows. “The trade deal certainly helped remove one of the overhangs for FIIs, as reflected in the recent uptick in foreign inflows and a firmer rupee. However, it is not the only hurdle. A weaker rupee and muted Nifty earnings trajectory, likely in 1HCY26, remain headwinds for sustained FII inflows,” he said.
Shah sees conditions improving in the second half of the calendar year. “We see scope for this equation to turn favourable in 2HCY26 with potential Fed cuts, which typically lead to emerging market inflows, improving earnings momentum in 2HCY26, our expectations of a continued reform push by the government, potential upsides to budgetary estimates providing room for fiscal stimulus in 2HCY26 and a decision on the quantum of Pay Commission hikes,” he said.
Worst of downgrades over
On the Q3 earnings season, Shah acknowledged weakness. “So far, companies that have reported earnings within the Nifty have registered Q3FY26 earnings growth of 5% YoY and this is broadly in line with our and the Street’s muted expectations. We expect this weak momentum to continue into Q4FY26 and expect Nifty to register just 7% earnings growth in FY26,” he said.
However, he anticipates acceleration ahead. “We believe Nifty could see earnings accelerate to 13.5% in FY27, supported by a pick-up in loan growth for financials, improving discretionary demand aided by GST cuts, telecom tariff hikes, stronger realisations for non-ferrous metals and a favourable base for IT and staples. Further, we believe consensus earnings downgrades are now largely behind us,” Shah said.
Will AI kill IT?
On concerns about AI tools disrupting India’s IT services sector, Shah downplayed the risk. “We think that the plug-ins being released by AI companies matter more for the software companies and do not change much for the IT services companies,” he said.
“The broader developments around AI’s use in business have been moving more constructively over the past few months. Companies have been highlighting the increasing opportunity available for them as more AI pilots move into the implementation phase and that their partnership with AI-first companies is driving up demand for enterprise-grade AI solutions,” Shah added.
On valuations, he noted, “Post the correction, large-cap IT stocks are trading around 20 times one-year forward earnings, which is a marginal discount to their 10-year average valuations. We would continue to maintain a selective stance on the sector and prefer only those companies where visibility of acceleration in growth in FY27 is high, backed by their ability to participate in AI services spends and where there is a proactive and concerted push towards an AI-led operating model.”