>Priced to perfection (MERRILL LYNCH)
Expect correction in Q1; year of consolidation; index target 18,000
2009 has been a big surprise and is on track to be the best year for markets since 1991. The surprise for 2010 can be that it is a year of consolidation rather than the “boom-bust” years seen recently. The last time we had a single digit move in the market was in 2002. While liquidity will likely remain easy for an extended period of time and earnings and the economy are recovering, we think valuations are pricing in a lot of good news. We expect markets to correct in Q1 led by:
1. Rising inflation: We think inflation can hit 5% by December 2009 and get close to 8% by March 2010. Rising inflation has been historically negative for markets on 5 of 7 earlier occasions.
2. Exit policy by Government/RBI: We expect the RBI to start hiking CRR/repo rate in January and the Government will likely start phasing out its stimulus in the budget in February through roll-back of some excise duty cuts.
3. Burgeoning supply of paper: We see supply of paper of nearly $7-8bn (including Government disinvestment) in Q1, which will absorb the surplus liquidity. The de-leveraging by corporates will also mean lower sustainable RoEs.
Government policy key to market
We think the timing of the “exit policy” of Governments/central banks, both in India and developed markets, will be key to markets. The pace of reforms by the Indian Government (disinvestment, infrastructure, GST) will drive re-rating.
Can markets hit their all-time highs?
If surplus liquidity conditions prevail, there is a possibility of bubble like valuations some time during the year. However, we don’t expect this to sustain. Based on historical V-shaped recoveries, markets have fallen 30-40% after hitting earlier highs.
Sector strategy – domestic plays still
Global cyclicals account for 45% of our EPS growth in FY11. However, we still remain O/W domestic plays – banks, infrastructure and autos are our biggest bets followed by pharma.
Most preferred stocks: SBI, Mahindra & Mahindra, Dr Reddys.
Least preferred stocks: Ambuja, Infosys, NTPC
1. Liquidity vs. valuations – Sensex target 18,000
2009 has turned out to be a big surprise. It is on track to be the best year for markets since 1991, though after a disastrous 2008.
Surprise of 2010: A market consolidation
So what can be the surprise for 2010? We expect the “surprise” in markets in 2010 to be a year of consolidation rather than the “boom-bust” years we have got used to over the past few years. The last time we ended a year with a single digit move (either positive or negative) in the market was in 2002 and 2004 was the last year with a move of under 25% in the markets. Our Sensex target of 18,000 for the Sensex prices the market at 15x FY12E earnings. The positives for the market are well flagged:
1. Global liquidity is likely to stay easy for an extended period of time and provides the backdrop for the rally in equities.
2. The Indian economy is recovering and we expect GDP to grow at 7.8% in FY11 vs. 6.2% in FY10. Industrial production growth is likely to accelerate to double digits from a low of 3% early this year.
Can market hit its all time high in 2010?
This is not our base case. But if the easy liquidity conditions globally lead to an asset bubble, we could get equity markets hitting the old highs. However, we do not think the markets will sustain at these levels in 2010.
Even if we look at past history on the 2 occasions that market had fallen more than 50%, it took 294 and 571 days to hit the old peak. This means we should hit the peak between May 2010 and June 2011. Interestingly, on both these occasions, the markets gave a 30-40% negative return in the next 6 months.
Government policies important determinant of markets
We think the Government policies will be an important determinant of markets in 2010.
1. The global central banks and the Governments in developed markets will be a key driver of global liquidity.
Global recovery, no double dip
Global recovery in 2010 supports Indian growth
BofA Merrill Lynch economists expect a global recovery in 2010. We do not share concerns about a double dip, given that economic policy should remain accommodative of recovery. Global GDP growth is forecast to turn around to 4.3% in 2010 (and 4.5% in 2011) from a contraction of 0.8% in 2009 (Table 8). The US, in particular, is expected to see a “square root” recovery to 3.1% in 2010 (and 3.3% in 2011) from the particularly sharp GDP contraction of 2.4% in 2009.
To read the full report: INDIA STRATEGY