Negative momentum to last till June 2011, Sensex likely below 16000
We believe there are three major concerns for the market currently: 1) High inflation, which it is feared that the RBI can only control by further slowing growth; 2) Policy paralysis by the government in terms of reforms and administrative decision-making is causing inordinate delays in the much-needed improvements in physical, financial and social infrastructure; and 3) Anecdotal evidence continues to suggest a weakening economy even before interest rate increases impact businesses.
3Q11 earnings were disappointing on the whole, with very few sectors seeing earnings upgrades. In fact, most of the 'local' sectors have seen sharp cuts in forecasts.
We believe the shift in location of growth momentum is additive, and materially strengthens the medium-term growth potential for India: with a 12% lower industrial ICOR (2004-08), under-developed states can deliver stronger growth with the same capital. That said, it does not preclude cyclicality in the overall economy, and the under-developed states are not yet large enough to offset a slowdown in the developed states.
This will continue to impact the stock market – GDP growth and market multiples are strongly correlated. Worse, we believe the slowdown would 'feel' worse than reality, as the economic bell-weather sectors (construction, cement, real estate) are 'local' in developed states. They are an insignificant 3% of the Nifty EPS but by influencing perception of how well the economy is doing, have a much more significant impact on the market.
This is likely to be exacerbated by fund flows – we estimate only about 20% of the ETF and 2% of non-ETF FII flows seen in 2010 have reversed YTD. The market may languish till mid-CY11, falling to 16,000 levels. We would avoid 'local' sectors.
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