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With the Sensex strong 35% rally from the 9th March low, 15 of 98 stocks in our coverage are within 10% of their 52 week high; 8 are trading 1 standard deviations above five year average P/E multiple. Among stocks in this set, Maruti, GAIL, IOC, BPCL and Glaxo look set to give up gains. While we see market performance being capped by the risk of weak governance in the backdrop of the challenging macro situation, we still see positive risk-reward in Bharti, Cipla, ITC, ICICI Bank and Sterlite.

Best and worst performers
■ 26 stocks in our universe have gained >50% since 9 Mar. As expected in a liquidity driven rally, asset plays, deep cyclicals and highly geared companies dominate.
■ Print media stocks, Educomp and Wipro have been the exceptions.
■ On a YTD basis, however, domestic cyclicals, especially autos and cement, have been the stars – driven by the pick-up in volumes in recent months.
■ Zee (+17% since 9 Mar, -23% YTD) and Nalco (3.5%, 6.6% YTD) are the non defensives
among the laggards, but Nalco has also seen big earnings downgrades.

Already discounting a move into a bull market?
■ 15 stocks are within 10% of their 52 week high. Non-defensives in this list are Hero Honda, Maruti, Union Bank and oil R&Ms IOC and BPCL.
■ While easing in volume growth, margin pressures will weigh on the Maruti stock, IOC, BPCL – facing a rise in crude price, weak refining margins – are near target.
■ Among non-cyclicals, GAIL, Bajaj Auto and Glaxosmithkline are trading at >1 sd above 5yr average P/E. GAIL has downside to our target price, with little prospect of earnings upgrade; Glaxosmithkline 19x P/E looks rich given weak growth.

Where are we seeing earnings upgrades?
■ Only 15% of covered stocks have seen FY10 EPS upgraded by 5% or more. While banks dominate this list, other constituents from the auto, cement sectors and Godrej Consumer have seen big stock appreciation as well.
■ Biocon’s 20% upgrade reflects adjustment in booking of FX losses; we retain U-PF.
■ For the Sensex, FY10 EPS has been cut 15% since the beginning of the year. We see upgrades to overall EPS being limited by risks to profits of commodity plays.

Caution ahead of elections
■ The most likely scenario for the new government at the centre, post the May-09 elections, remains one that will be weaker than the current one.
■ We retain our year-end target of 11,000 for the Sensex. We see little visibility on the earnings upgrade cycle and expect macro risks to cap valuation multiples.

To see full report: MARKET STRATEGY