India Market Strategy
STRATEGY
The bottom of the “U”
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We expect the Sensex to repeatedly go across 9,000, as politics and
corporate India’s loss recognition negate policy easing and economic
data improvements in 1H09.
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We identify 10 major themes or events with significant investment
implications when markets tread water amid consolidation among
shareholders, investors, corporates and policymakers in 1H09.
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Depending on the corporate events in 1H09 and more importantly on
the mid-2009 election outcome, the market may rise 30-40% or fall
sharply in 2H09. Bottom-up, value-driven investment in quality
management companies is the best strategy – and more important than
sector allocation – in these uncertain times.

The bottom of the “U”
Time for the range-bound markets
It has been the case in India, and also in many other markets, that many of the longest
range-trade periods for equity indices are observed after sharp plunges. Markets do not
normally undergo a V-shaped rebound after massive economic turmoil because the losses
created need time before they are fully recognised, allotted and recapitalised. Statistically,
stock market volumes and volatility reduce sharply in this phase. Historically, large caps
have been observed to outperform smartly in this period, which makes sense
fundamentally, too, because of the general emergence of corporate governance and
liquidity risks in this phase. Unlike in the previous bear market phase, typically the low beta
sectors stop outperforming when markets turn range-bound. Outperformance is less
sector-based and more stock-based in this phase.
A growing list of positives protecting the downside
Every market fall ends somewhere. It is not a given that the Indian market cannot fall
further, but valuations and significant economic policy support plus pessimistic
expectations suggest to us that more downside for the market will be possible only if some
new negatives emerge – such as more corporate governance episodes like Satyam
Computer (SATY.BO, Rs34.40) or an extremely weak government post elections or
another major global market collapse. Indian equities look compelling on absolute
valuation measures and when compared against falling interest rates. We are more
heartened by improvements in the economic series like inflation and the current account
which should allow policymakers to ease policies further.
Large negatives to cap the upside
While we do not expect any of the risks in corporate India, politics or global environment to
blow up, we see fewer chances for a positive move in the Sensex in the coming six
months because of their overhang. Earnings forecasts remain unrealistic, even if this is
now accepted by most investors. Negative corporate surprises in the name of “one-off”
losses are likely to be a regular feature in the coming months. As the market waddles
through this, pre-election uncertainties are likely to sap investor enthusiasm soon.
These have been particularly extraordinary times for the followers of Indian equities. The
fall triggered by global market collapse is likely to stay etched in investor memories for
decades. The pace of policy easing in 4Q08 and also the economic fall is likely to stay
unparalleled for many years. The terrorism attacks in Mumbai and Satyam’s
announcement are two other events that will not only fill all sorts of commentaries for a
while but will also impact the market direction. And, in elections, we may have the biggest
of one-off events for the market in coming months. In conclusion, only with a strong,
reform-oriented government, and with the help of a global market, the Indian market could
end the year with a sharp 2H09 recovery.
Stock picking: less about sectors, more bottom-up
Unlike 2007, which was a year of high beta stocks/sectors and its reverse in 2008,
investment success in 2009 is unlikely to depend on the selection of stocks from any
particular beta range. We feel that selections on relative value or earnings risks may not
work in the range-trading 1H09. We recommend investors select large-cap stocks with low
gearing and market leadership in their own segments. Investors should prefer the flagship
companies of business groups that can quickly alter their capex plans and revert to
positive cash flow generating ways. Investors should avoid mid- and small-cap stocks
where liquidity premiums could rise. Most importantly, investors should overweight stocks
with good management reputations, track records and low corporate governance risks.

10 likely trends of 1H09
1) Unprecedented policy easing: 1H09 should see inflation and interest rates at levels
almost never seen in history. It would be wrong to assume that fiscal and monetary
policy easing are likely to stop soon. Policy easing, along with valuations, is the main
reason why we do not think the market will fall much below 9,000 without unforeseen
political upheaval.
2) Growth uncertainties: Despite significant improvements in many economic data,
lacklustre growth prospects are expected to bother investors the most. Weak growth
and political uncertainties are likely to ensure the Sensex does not rise much above
current levels sustainably until elections in the middle of the year.
3) Loss recognition: Corporate India’s consolidation should have three major steps. In
the first stage, an increasing number of companies should declare losses – most will
be branded as “one-offs” – because of the asset market falls of 2008 and due to the
ongoing economic slowdown. FY10 final earnings could come in 25-30% below the
current consensus.
4) Loss allocation: In the second step, the losses should undergo innovative and often
conflict-causing processes, as they are digested. The innovation could be in how they
are reported or hidden in P&L. Regulators could play an important role in abetting or
cleansing this process. Headline-grabbing events, however, could be the conflicts
between majority and minority shareholders, group companies and creditors.
Investors should invest in quality companies to reduce such risks.
5) Recapitalisation: Finally, many companies from distressed sectors, such as real
estate, construction and mid-cap segments, would need to raise equities even at
depressed prices before their operations could stabilise. Avoid companies facing
dilution prospects despite significant falls in their share prices.
6) Bank NPLs: Few emerging market slowdowns have been traversed without banks
undergoing any decline in asset quality or profitability. Despite the policy easing and
regulatory forbearance, banks remain at risk given the extent of losses that have been
created. UNDERWEIGHT.
7) Major shareholder consolidation: We expect conservative Indian business groups
to restructure and return to positive cash flow ways by focusing on core competencies
and postponing expansion plans in unrelated areas. Investors should OVERWEIGHT
flagship companies of key business groups and UNDERWEIGHT the peripherals.
8) Minor shareholder consolidation: Investors of all kinds are expected to turn more
focused on liquid investments, as risks become more evident in relatively illiquid real
estate, mid/small-cap companies and non-orthodox investment vehicles. New trends,
including withdrawals, could be seen among local investors.
9) Regulator consolidation: We expect rules to change continuously not only for
investors and corporates on disclosures, as losses turn more painful, but also for
industries, banks and businesses, as regulators come under pressure to prevent a
repeat of some of the abuses that have taken place in the past few years.
10) Political events: In the end, we expect the market to be most influenced by elections,
results and the policy framework adopted by the new government in mid-2009. A
strong government and reform-oriented policies could help foster an environment
where investors look beyond the remaining pains of the ongoing slowdown and refocus
on long-term fundamentals. Alternatively, a weak government or wrong policies
could be slammed hard by investors in a fragile environment. Despite all historic
economic announcements and likely substantial corporate developments, nothing may
matter more than politics.