>Stress case suggests moderate downside (DEUTSCHE BANK)

While we are maintaining our baseline view of Indian economic growth moving back to the 8-9% GDP growth trajectory driving corporate earnings growth in India (and hence maintaining our year end Sensex target of 22,000), 3QCY10 should see equity markets being swayed by dramatic waves of risk aversion We have attempted to provide a framework for investors by running a stress test for the BSE Sensex companies and determining the likely downside risk from a moderate global risk event. Our stress tests indicate that there is a ~14% downside risk to our base case Sensex earnings forecast of 1095 for FY11. In case our stress tested scenario pans out, BSE Sensex earnings in FY11 would rise by only 12% relative to our currently estimated Sensex earnings growth of 30%. Based on our stress tested EPS and applying the current market multiple of ~16xFY11 earnings, the fair value of the BSE Sensex would be 15,100. We believe that this provides a reasonable floor value to the Indian market, in a moderate global risk scenario.

■ Declining oil prices – a strong tailwind for India
Our global commodities team expects oil prices to soften in 3QCY10 and remain weak into the end of the year before recovering in 2011. We believe declining oil prices will result in a strong tailwind for India’s domestic economy as well as its balance of payments. A downdraft in global oil prices should help take considerable pressure off an inflation-wary government of India and allow it to
perhaps extend the recent bold deregulation of petroleum products to diesel. The government’s recent decontrol of petroleum prices and the promise of extending this to diesel have been seen as a strong game changer and bring back faith in the Indian government’s commitment to make bold decisions that a popular democracy generally constrains it from implementing.

■ India’s share in regional inflows has ratcheted up sharply
The improving domestic macro situation and India’s unique domestic consumption model has perhaps been the critical factor for the country’s out performance relative to its other large emerging market peers. India’s share of regional inflows in 2010 YTD underscores this thesis. India’s share of regional (Asia ex China/Japan) FII flows (2010 YTD) has ratcheted up sharply to 48%. This compares favorably to 2009, when India received only 29% of regional inflows (with Korea having seen the largest flows then), and 2004/2005 when the share stood at 30%
and 33% respectively.

■ Model Portfolio tilted partially towards defensive plays
Driven by our expectation of a volatile 3QCY10, we have added a more defensive bias to our model portfolio. While we continue to overweight Banks, Industrials and Automotives, we have also shifted Telecom as a non-consensus overweight. Despite strong under performance since May’10, we have gone underweight on Metals as we believe that global headwinds and regulatory concerns will keep investment flows into commodities depressed. Other underweight sectors are: energy, healthcare and Cement. Our Top Buys are: M&M, Maruti, Zee, Axis Bank, HDFC Bank, Lanco, L&T, BHEL, Asian Paints and Tata Steel.

To read the full report: EQUITY STRATEGY