>INDIA EQUITY STRATEGY: 2012 Outlook: Structural Pain In, Cyclical Gain Not

■ Structural snags... — India’s ‘secular investment story’ has taken several twists over

the year. The ‘democratic government’ has become directionless, the ‘fortune at the

bottom of the pyramid’ has turned into a structural inflation infuser, the ‘capital inflow

window’ has tipped into a currency crunch, and India’s much feted ‘entrepreneurial

energy’ has become more of a corporate governance quagmire. Yes, a lot has changed

in a year – including GDP growth expectations sliding from 8% to 7% – but it is the

-30% YTD currency-adjusted market swing that is now most dominating the mood.

■ ...and cyclical stress – but cycles do turn — Inflation and interest rates are high,

government activity is low, oil is rising, capital is not coming, confidence is waning and

earnings growth is falling. But there is another way of looking at this way: Inflation is

statistically set to go down, interest rates will not continue to rise as demand falls (and

aggressive policy could well bring about rate cuts), and the government has recently

done more than in 2 years. And valuations are relatively attractive (and meaningfully so

for any inbound M&A activity – businesses are 30-40% cheaper than a year ago) and

earnings growth has been cut almost as sharply as in 2008. Cycles can be deep, but

by definition they turn…sometime.

■ Economy increasingly vulnerable to markets – Needs some luck — India’s high

dependence on excess external capital – for corporate/ investment growth, filling its

current account gap and keeping interest rates low – has only increased as the

economy has grown. What can be a virtuous circle has turned vicious – India is more

vulnerable now than at higher market and Rupee levels. The economy needs support

from the markets for the circle to revert to being virtuous: Risk on, easing inflation,

falling oil, falling commodities or other global market drivers/events.

■ Upsides, likely to be front-loaded — We set a 18,400 Dec 12 Sensex target (5520 on

Nifty), at a 1-year Fwd PE of 14x (a 10% discount to the long-term average as India

has fundamentally de-rated). We expect positive market movements to be more upfront

than back-ended (cyclical gains with structural caps from slower growth and FX

vulnerability), and have tweaked our model portfolio to continue to position relatively

aggressively. Overweight on Banks and Autos, in addition to the relatively defensive

telecom sector and pharma businesses. And underweight in Materials, IT, Utilities and

Consumer.

■ Top picks for 2012 — Our top buys for 2012 side are Axis Bank, SBI, Tata Motors,

Jindal Steel & Power and Dr Reddy.

To read the full report: EQUITY STRATEGY

RISH TRADER