Silver lining in the midst of dark clouds --ShareKhan PDF link

Silver lining in the midst of dark clouds   Markets are poised for relatively better times ahead Market negotiates through a tough global environment and a seasonally weak summer: In our last Market Outlook report released in early May (titled "The heat is on"), we had turned cautious against the backdrop of the rising crude prices and the nervousness prior to some important global and domestic events in the already seasonally weak summer period. The market did lose some ground and the overall pessimism only heightened on the back of the Reserve Bank of India (RBI)'s status quo on policy rates, the downgrade of India's rating outlook and the fragile euro situation during the last two months. However, we believe that the Indian equity market has negotiated the tough period without much damage and is potentially poised for relatively better times over the next few months.

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Emerging positives amid despondency: Given the slew of negatives, some of the positive developments and pointers have been largely ignored. These are as follows. Commodities cool off (including crude): A decent correction in commodities especially crude oil is inherently positive for the Indian economy, the corporates and the equity market. It does three things: eases the pressure on fiscal health; positively affects corporate margins and makes India better placed for foreign investors as compared with its commodity exporting peers like Brazil, Russia and Indonesia. Political changes could end policy inertia: The domestic political situation has turned more conducive with the prime minister taking charge of the finance ministry as well and the Samajwadi Party (SP) formally putting its weight behind the United Progressive Alliance (UPA) II, thereby marginalising the troublesome coalition partner Trinamool Congress' importance in forging a political consensus to push forward the pending and much awaited policy decisions. Mind you, we do not expect any major fireworks or path-breaking reforms but the very breaking out of the policy inertia is enough to boost the market's confidence as expectations are pretty low. Valuations and high cash levels supportive: The rupee's depreciation has turned the valuations of Indian equities all the more cheaper for foreign investors who are sitting on a record level of free cash (especially the Asian and emerging market funds), according to one of the recent surveys done for a global bank and research house. Euro zone: kicks the can down the road again: The euro zone members have come out with a patchwork of a solution to soothe the unnerved financial markets. The plan to directly support European banks and intervene in the bond markets to support member states has led to a burst of optimism which could fade off after the initial reaction.  Pressure points: resumption in earnings downgrades and weak beginning of monsoon season: It could have been better for the Indian equities but for the disappointing Q4FY2012 results of some index heavyweights and the overall resumption of the downgrade in the consensus earnings estimates by research houses after a pause of a few months. The higher than expected asset quality concerns in the banking sector was the key negative takeaway from the Q4 report card. The monsoon could also play a spoilsport. The beginning is weak and the increasing probability of El Nino in the later part of the monsoon season would put further pressure on the economy, which is already suffering from slowing industrial activity with signs of a slowdown in the services sector also. Moreover, a weaker monsoon would boost inflationary pressures and could further delay the easing of the monetary cycle.  MARKET OUTLOOK No runaway rally but sentiments could change for better: Having said this, we are not in any way implying that the benchmark indices would witness a runaway rally from here but are merely suggesting that the bias should turn positive from negative in the near term. The important thing to note is that in such an environment the beaten-down stocks from certain sectors where some policy decisions are initiated could surprise positively and outperform the currently fancied consumer and other defensive stocks in the next couple of months. Beaten-down and high-beta stocks from light engineering and construction/infrastructure sectors could turn out to be rewarding contrarian bets in such a scenario. The delay in the interest rate cuts would act as a drag on the rate sensitive sectors (especially automobiles) and the highly leveraged companies. In terms of valuation, the Sensex trades at 13.3x its FY2013 estimated earnings and 12x its FY2014 estimated earnings (in rupee terms). That is close to 15% discount to its long-term average multiple of 15x its one-year forward estimated earnings. Click here to read report: Market Outlook

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