'Crash? Scope for 12-15% earnings growth'

Morgan Stanley Managing Director Ridham Desai comments on the current market scenario and prospects that lie ahead for investors.

What is causing such massive correction in the Indian markets?

The Indian equity market has once again demonstrated its high beta characteristic in bear markets. The fundamental underpinning to this high beta status in bear markets is India's dependence on global financial markets to fund its macro -- more than three-fourths of the flows into India come from portfolio sources (which are linked to global financial market outcomes) -- quite the opposite of the emerging markets average.

More recently, the market has been driven by retail speculators and valuations have been rich. Here are some points to ponder:

• The market is still 20 per cent up from its August low. Until Friday, the Morgan Stanley Capital International (MSCI) India index had outperformed the EM index by 30 per cent in dollar terms. Tuesday's correction will trim the relative gains but they are still high.
• The Sensex is now trading at 15.7 times financial year 2009 (FY09) P/E, higher than its ten-year average of around 13.6 times.
• The consensus estimates the BSE Sensex constituents' aggregate earnings growth at 18 per cent and 19 per cent for FY09 and FY10, respectively. We think earnings growth could be around 12-15 per cent in the coming 12 months. The pace of upward revisions is likely to be tested in the coming weeks.
• The politics are relatively benign since we think that the national elections will take place according to schedule in the early summer of 2009. The next union budget (towards February end) could be a trigger as the government may focus on further tax reforms, infrastructure spending as well as rural spending.
• The recent initial public offerings have locked up significant amount of cash as margin money causing a liquidity crunch. This cash will be available to the secondary markets in early February. Whether this money comes to the market or not may be dependent on market sentiment at that point of time.
• Local sentiment has been hit heavily with breadth declining sharply, outstanding positions winding up and fresh shorting of Nifty futures. There may have been aggressive margin selling.

What is the outlook for investors?

The outlook is pinned to global outcomes and we think India could underperform if the global financial markets continue to decline. The immediate technical support level seems to be around 15,700 on the Sensex, about 10 per cent lower than the current level.

We think investors should expect volatile market conditions and if the Sensex does test the gap at 15,700, it will not be far away from our fair value estimate of 14,864.

We recommend the narrow market over the broad market on a relative basis, given that large caps look better fundamentally as well as on the valuation front.