>INDIA STRATEGY (RELIANCE EQUITIES)

BOOM AND BUST

Resistance is futile
As the markets gain new heights, investors are now worried whether the rise is too fast to last. We worry as well. But our analysis suggests resistance might be futile. On the back of a sharply improving 2011 earnings that, in turn, should benefit from rising availability and falling cost of capital, we expect the BSE Sensex to rise to 18000 in the next 200 days. In this note we go through the rationale and help you position for that rise.

■ 18000 by year end
We expect the BSE Sensex to trade between 17x and 19x FY11 earnings by December 2009, which, in turn, is expected to rise by an impressive 17-22% over FY10. There is scope, however, for a further rise in the market’s multiples. Put simply, India is at a significantly superior growth and risk category relative to its past cycles or competing global investment destinations. Past cycles have seen better than 20x one-year forward earnings.

■ Global forces to determine returns
Domestic factors like elections might appear to trigger the rally, but make no mistake: the Indian market will be dominated by global dynamics. The excess liquidity created by the global monetary authorities WILL drive asset prices, and in particular emerging markets, higher. Capital costs are key for consumer and investment demand in India. On the back of expected greater credit availability and falling credit costs, our economist expects Indian FY11 GDP growth of 7%. The global asset allocation shift will magnify the dollar-denominated returns from markets like India, feeding a virtuous cycle.

■ Material risks remain and are rising
While we wish it could be a one-way bet, risks are indeed rising in global markets that could, in turn, impact India. The wall of liquidity could well fuel inflation in developed markets resulting in monetary tightening. Such a tightening would impact the key driver of Indian earnings—the availability and cost of capital. For the moment, though, rising global bond yields are a good sign. Indian markets have significantly outperformed global and most other emerging markets but this is not new and could continue as many domestic investors have been sceptical and are playing catch up. It is extremely rare for Indian markets to have just a 12-14 week rally: the average is 53 weeks.

■ Launching Reliance Equities International Model Portfolio: “REIMP”
We launch our model portfolio, REIMP, along with a recommended sectoral asset allocation. This is a synthesis of our bottom-up and top-down view.

Nice run but where next?
In late March, we set our Sensex target for the year end (December 2009) at 13700 and launched our deep value portfolio, REIDV. Little did we realise how “short sighted” the target would prove to be. As we watched the post election relief rally in amazement, the question arose: what is the year-end target now? Cutting to the chase, we now see the market in the 16500-19000 range by December 2009, i.e., about 15-30% upside from here.

The market currently trades at about 15.5x our March 2011 bottom up earnings estimates or about 19x March 2009 earnings. This might appear fairly expensive. Figure 1 below suggests that, relative to the history of the market, it really is not. At the cusp of the cycle, it is usual for analyst estimates to lag significantly. Analysts wait for hard data prior to revising earnings. Alas, markets do not wait for such niceties. Markets typically move ahead of analysts and such other mere mortals discounting somewhat incomplete or inconclusive data and more distant future earnings resulting in a significant expansion or contraction of trailing P/Es.

We base our revised target on what we consider to be the most plausible scenario but with a margin of safety—a Grahamesque concept. Our target is based on FY11E EPS growth of 17-22% and a P/E of 17-19x FY11E. Looking at it from a trailing earnings perspective, our target implies a trailing P/E of 22x FY09 consensus earnings. In the last two market recoveries, one-year forward P/Es crossed 20x while trailing P/Es crossed 25x.


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