>ECONOMY & STRATEGY: Investment Implications; Key Assumptions made in our inflation model and the ‘Hysteresis Factor’ in the Indian context

With 4QFY12 promising plenty of negative newsflow from India and Europe, our Sensex target of 14,500 remains in play in the first two months of CY12. However, from March onwards, we see the situation improving for the Indian equity market thanks to a reversal in the RBI’s monetary policy stance, significant monetary easing in the West and a semblance of order returning to New Delhi’s policymaking. On a 12-month basis, we see the Sensex moving towards 18,000.

Sensex 14,500 remains in play in Q1CY12…

The first two months of CY12 will be a challenging period for the Indian market for three reasons. Firstly, the Q3 FY12 results season promises to be anything but cheerful and is likely to result in consensus’ FY13 EPS estimates being pulled back further by around 3% points. Secondly with key state elections being rescheduled to end by 4th March, policy chaos is likely to persist over Jan-Feb 2012. Thirdly, Europe is set for a tricky couple of months with: (a) Italy and Spain likely to auction US$180bn of sovereign debt from 12th Jan onwards; (b) European banks must report to their central banks by 20th Jan, as to how they will get their core tier 1 ratio to 9%; and (c) The 17 Eurozone countries will attempt to get their Parliaments to approve the 9th Dec intergovernmental agreement by March 2012.

Hence in the opening 2-3 months of the calendar year, our longstanding Sensex 14,500 target remains very much in play.

… but over the course of CY12, the Sensex should veer towards 18,000

From March 2012 onwards we see the tide swinging in India’s favour. Firstly, with the counting of votes for the State elections drawing to a close on March 4, 2012 and with the UPA administration realizing that it is in the last chance saloon, we expect to see more decisive and more reformist policies from the Government (including retail FDI) in the Budget session that is likely to open in mid-March. Secondly, with economic growth waning, core inflation (33% weightage) is likely to ease and presuming no further advances in global commodity prices, WPI inflation in India is likely to moderate thus triggering RBI rate cuts from March 2012. Thirdly, with the Eurozone heading for a recession, which could slow down the nascent American recovery as well, we expect serious monetary easing (including QE) from the ECB, the Federal Reserve and the Bank of England. In totality, we expect this easing to be comparable with what we saw in the months after the collapse of Lehman in CY08.

Hence over a 12-month period, we see a semblance of normalcy returning to the Indian market. Multiplying our FY13 EPS estimate of `1,160 (0.1% above our long standing FY12 estimate of `1,159: see pg 18) with a forward P/E of 15.5x (in line with India’s long term average) gives us a 12-month Sensex target of 18,000.

Stock specific implications

As you would expect, we reiterate our faith in “Good & Clean 3.0: Battleships”. Since its launch on 19th October this portfolio has outperformed the BSE500 by 377bps and 429bps on a market cap and equal weight basis respectively. Our overall family of Good & Clean portfolios has outperformed the market by over 13% points since launch in mid-March last year.

Beyond Good & Clean, our highest conviction BUYs are HCL Tech (HCLT IN, mcap US$5.1bn), Bank of Baroda (BOB IN, mcap US$4.9bn), Ultratech (UTCEM IN, mcap US$6.0bn), Mannapuram (MGFL IN, mcap US$0.7bn), Torrent Power (TPW IN, mcap US$1.8bn), Engineers India (ENGR IN, mcap US$1.3bn), Petronet LNG (PLNG IN, mcap US$2.2bn) and Oberoi Realty (OBER IN, mcap US$1.3bn).

Our highest conviction SELLs are Wipro (WPRO IN, mcap US$18.5bn), State Bank of India (SBIN IN, mcap US$19.5bn), Dabur (DABUR IN, mcap US$3.3bn), LIC Housing Finance (LICHF IN, mcap US$2bn) and Axis Bank (AXSB IN, mcap US$6.5bn).

To read the full report: ECONOMY & STRATEGY

RISH TRADER