>STRATEGY: Avendus advise cuts in allocations to Two‐wheelers and Consumer, and increases in Commercial vehicles, Passenger vehicles, Cement, Pharmaceuticals, Telecom, Metals and IT Services

Amidst the pervasive gloom, a few signs are pointing to better times returning sooner rather than later. The rapid fall of the Nifty PEG has brought it to within 10% of the band where it stabilized in 2009, before the next rally began. A ‘time‐correction’ could pull down the PEG to
0.7x in 1Q2012. The yield‐gap is down to near its three‐year mean. In the real economy, two lead indicators – Electricity generation and LCVs – are pointing to a rebound in Manufacturing. The missing element – lower interest rates – may be back soon, as seen in the recent fall in
bond yields. Shifts in earnings momentum suggest that sectors with strong links to the recovery are more likely to outperform in 2012. We advise cuts in allocations to Two‐wheelers and Consumer, and increases in Commercial vehicles, Passenger vehicles, Cement, Pharmaceuticals, Telecom, Metals and IT Services.


Steep fall in valuation; Nifty within 10%, three months of stable level
After falling from 2.0x to 0.8x in nine months, the Nifty PEG is within 10% of the range where the Nifty stabilized in 2009, before the next rally began. If prices and FY13 earnings forecasts stay at end‐Dec11 levels, the ‘time‐correction’ could push down the PEG to that range within three months. The yield‐gap to the 1‐year government bond too has fallen close to its three‐year mean, partly due to the fall in the Nifty, but more due to the large fall in the bond yield itself.


Latent signs suggest manufacturing recovery may be impending
Previous cycles saw the Electricity segment of the IIP rebound about six months before Manufacturing. A strong rebound in Electricity has now been under way for 14 months. Another similar lead indicator has been growth in sales of LCVs. Despite the leading indicators being flashed, the rebound in Manufacturing has not commenced. We believe the missing element in this cycle, that was active in the previous economic cycle, is a low interest rate regime. The fall in food inflation in Dec11 is significant as the food segment contributed over half the rise in wholesale inflation during 2011. The fall in the one‐year government bond yield has been a strong indicator of the fall in the Repo.


Tilt away from defensives may have begun
Late 2011 saw sectoral performances begin to shift from previous trends. There is a tilt away from ‘defensive’ sectors and towards stocks with stronger linkages to the next rebound. These changes are linked to the shifts in earnings momentum and have signaled the revival of ‘normal’ sectors such as Cement and Commercial vehicles. For 2012, we advise cuts in allocations to Twowheelers and Consumer and increases in Commercial vehicles, Passenger vehicles, Cement, Pharmaceuticals, Telecom, Metals and IT Services. Our top 10 stocks for 2012 are Bharti Airtel (BHARTI IN, Buy), Hindalco Industries (HNDL IN, Buy), HCL Technologies (HCLT IN, Buy), ICICI Bank (ICICIBC IN, Buy), Larsen and Toubro (LT IN, Hold), LIC Housing Finance (LICHF IN, NR), Maruti Suzuki (MSIL IN, NR), State Bank of India (SBIN IN, Buy), Sun Pharmaceuticals (SUNP IN, Add) and UltraTech Cement (UTCEM IN, Add).


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