Buy On Dips

India has been regarded well for standing tall during the global meltdown. The Indian economy is relatively less exposed to global shocks since it is domestic-driven. We estimate the Sensex fair value at 19,760 (16x FY12 EPS of `1,235).On a broad basis, we believe that the quarterly results are not a concrete gauge for judging earnings’ quality. Generally, Q3 and Q4 of any respective fiscal are the best in terms of results. However, the expectations from the second quarter will be huge given the kind of run-up in equities one has witnessed. The main sectors that will drive earnings would be automotive, capital goods, banking & financial services, and oil & gas. Globally, the economic conditions of the developed world will keep the markets volatile.

Also, the likely impact of the US getting into or avoiding a recession will impact on global liquidity, which is highly crucial for a market like India. Inflation, a problem for India, we believe, will recede from its current levels. Also, manufacturing-related inflation will start easing off. Apart from this, inflation would seem to be high because of the policy reforms that are in progress in the oil & gas sector. A high rate of inflation may augur well for agricultural commodities and the industrial metals sector as they will achieve better realisation for their products. On the other hand, it may be negative for manufacturing/construction/engineering companies as the cost of inputs will dent their operating margins. The new RBI indicated system of base rate would increase transparency in lending rates.

The base rate set by major banks is in the range of 7.5-8 per cent and has become a floor level for a one year kind of funding. However, this does not have any direct impact on the system rates as the base rate is a derivative of the rates applicable for the cost of funds and marginal profits. Around 65-70 per cent of the loans disbursed by the banks are at sub-BPLR. Now, with the base rate coming into play, large corporates that were accessing funds at lower rates in the 6-6.5 per cent range will have to pay higher rates, thus impacting their cost of funds. This may prompt large corporates to tap the debt market, consequently enhancing liquidity in the corporate bond market. Given the volatility in global news flows it is difficult to predict how the global markets would fare in the short-term. However, amidst the volatility, our sense is that one should keep a close eye on the global bond yields.[PAGE BREAK]

On the sectoral front, we have a preference for financials (return of the capex cycle, which will lead to an up-tick in credit growth and the better than the expected government borrowing programme to put less pressure on ten-year yields) and capital goods/infrastructure/industrials.We are also in favour of power (structural story intact and huge capacity additions coming on stream), hotels, media (pick-up in GDP and the improving industry outlook vis-a-vis relatively inexpensive valuations), and pharmaceuticals (the defensive and inorganic expansion drive of the MNCs to drive the M&A wave in the industry). We have a neutral view in the short-term while remaining overweight with an investment horizon of more than a year. The ‘buy on dips’ strategy is seen as the best strategy to build a long-term portfolio as at the fag end of FY11 the markets may not look expensive after incorporating the FY12 earnings.