Key macro-economic data showing signs of slowdown amid global concerns construct a challenging environment for Indian equities, says Morgan Stanley in a report released earlier today.
For Indian markets, the key problem is that US yields will keep real rates in India higher at a time when growth is already slowing down. Adding to it are concerns over US Federal Reserve winding down its bond buying program as early as the end of this month.
Amid expectations of a slowdown in economic growth, Morgan Stanley has trimmed their broad market earnings growth forecast for FY2014 to 6% from 12% and introducing an estimate of 5% for FY2015.
"We cut our Sensex earnings growth estimates from 10.5% to 4.1% for FY2014 and from 19.0% to 12.7% for FY2015. We issue a new 12-month forward Sensex target of 18200," added the report. Our key advice to investors is to remain underweight on banks and overweight USD hedges, the note said.
Given the tail risks, the global investment bank underscores its bear case and sees a 14 per cent fall in the Sensex, with a 35 per cent probability of 15,700.
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For Indian markets, the key problem is that US yields will keep real rates in India higher at a time when growth is already slowing down. Adding to it are concerns over US Federal Reserve winding down its bond buying program as early as the end of this month.
Amid expectations of a slowdown in economic growth, Morgan Stanley has trimmed their broad market earnings growth forecast for FY2014 to 6% from 12% and introducing an estimate of 5% for FY2015.
"We cut our Sensex earnings growth estimates from 10.5% to 4.1% for FY2014 and from 19.0% to 12.7% for FY2015. We issue a new 12-month forward Sensex target of 18200," added the report. Our key advice to investors is to remain underweight on banks and overweight USD hedges, the note said.
Given the tail risks, the global investment bank underscores its bear case and sees a 14 per cent fall in the Sensex, with a 35 per cent probability of 15,700.
The bear case scenario is only valid when India enters a near-crisis type situation with prolonged tightening and undervaluation of the INR. Sensex earnings are flat in FY2014 and up 5 per cent in F2015.
However, the outcome of the above given target will increase as we approach elections, cautions the global investment bank. The timing of elections is uncertain and there is an active probability that elections may happen ahead of schedule (currently April 2014).
Better-than-expected outcomes in most of the mentioned scenarios will lead to a bull market where earnings growth accelerates to 10 per cent and 15 per cent in FY2014 and FY2015. With a 15 per cent probability, Sensex can rally towards 23800 in a bull case scenario.
The new macro forecast implies that the earnings trajectory will weaken in the near term and the ensuing recovery is likely to slow.
Gross Domestic Product (GDP) data released post market hours of Friday showed that the Indian economy grew at 4.4 per cent in Q1, 2013-14, even lower than 4.8 per cent observed in the Q4, 2012-13.
Effectively, the two-year CAGR in broad market earnings is likely to be negative (at -1%). The Sensex may fare better with a two-year CAGR in earnings of 8% in our base case.
Apart from slowing growth at home, the global liquidity construct is also challenging for equities. For Indian markets, outcomes of US growth which includes US yields and USD, Chinese growth, Indian elections, India's policy response to the fiscal deficit and the state of real rates and oil prices will all play an active role in determining the trend.
The market's P/B has entered the bottom decile and this is usually a level from which losing money on the index with a one-year forward view is a rarity. However, bear in mind that, like in the late nineties, the market can remain at depressed valuations for an extended period, warns the investment bank.
From here, the RBI needs to reaffirm that high rates will linger (via a repo rate hike, for example) and the government needs to endorse fiscal consolidation which could be at risk. A steep diesel price hike could be a good change.
Sans policy measures, the market will be punitive with prices especially the INR forcing macro rebalancing. The INR appears undervalued and the more undervalued it gets, and the longer it stays that way, the quicker will be the macro rebalancing that India needs.
This will then pave the way for lower yields and higher share prices, believes the global investment bank.
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