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Merrill Continues to be Bearish – Big Rally in Late 2009

November 21, 2008

Merrill Lynch continues to be bearish on India mainly due to slowing economy hurting earnings and the uncertainty of general elections as we move towards the summer of 2009 [Q1-2009]. Economic news should continue to adverse through most of 2009, expect equity markets to recover in 2HCY09. Markets have typically given a over 30% return from its bottom and we could see such a rally start towards Q4CY09 led by – liquidity, lower inflation and fall in interest rates. This is the time when earnings downgrades will be behind us and the earnings revision ratio bottoming out.

Merrill Lynch expects the Sensex to hit 7000 levels in 1QCY09 as earnings get downgraded and drag valuations to historic lows of below 8x PE. Expect FY10 to see a flat to negative EPS growth which would bring Sensex EPS to the 850-900 levels.

Sensex EPS Estimates:
Sensex earnings is continuously turning gloomy. For FY09, expectations was at rs 980 and currently has fallen to Rs 925. For FY10, the Sensex EPS estimates is expected to be Rs 1,030 [bottom up approach, likely to be revised downwards] down from Rs 1,170 at the beginning of this year. Macquarie also estimates that earnings could be flat to negative in FY10 when compared to FY09. Investors can take individual stock selection approach rather than the SENSEX in view.

Merrill is Overweight on Telecom, Financials, Pharma, Consumer Discretionary [Like Hero Honda etc] and select Industrials [BHEL etc]. Neutral on Consumer Staple. Underweight on Energy, Real Estate, Software and Metals. For the time being avoid Mid Caps is Merill’s mantra as they are more vulnerable to adverse economic cycle and could see substantial earnings downgrade.

Global Slowdown is Impacting India:
India is relatively resilient, expect growth to be impacted by the global slowdown in the absolute sense. This emanates from demand contraction as a result of weakening exports and supply constraints as a result of lower external funding for investment. India should fare relatively better than most Asian economies because of its domestic demand story, with exports, at about 12% of GDP, the least in the region. [This is exactly what Mr. Jain at HDFC Fund had said to us in a conference call]

Political Instability:
2009 is the year of the general elections and the first half will likely be devoted to concerns on the nature and shape of the new Government. While it is early days yet, initial opinion polls could predict a hung Parliament which would be negative for market sentiment.

Indian Capital Market history suggests that as the economic cycle turns down, valuations tend to go below the 10x PE levels and hit the sub-8 levels, a level still to be reached. We believe valuations will hit an all time low in the coming months as earnings downgrades accelerate.

Related Reading:
Long Term Technical Analysis of BSE Sensex – Target 7,000

How Foreign Investors are Looking at Indian Markets and Economy ?

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