Market Stratagy of February 2011


Sensex valuations factoring in growth, inflation and current account deficit headwinds

Since the past few months, a host of information flow has been suggesting near-term execution hurdles to India's double-digit growth ambitions, and we expect GDP growth to be closer to 8% in the near term. Secondly, the current account deficit is expected to be as high as 3.5% of GDP in FY2011 and WPI inflation as high as 7% pointing towards rupee depreciation in our view. The current market correction can be attributed to an interplay between these two factors.

Even with GDP growth trajectory at 8-8.5%, the Sensex is looking reasonably valued trading at 14.4x one-year forward EPS, 14% below its average P/E since April 2004. Also, going forward, we believe that an increase in policy reforms, faster project clearances and further fiscal consolidation would hold the key for taking the GDP growth rate beyond the 8-8.5% expectations. At the same time, gradual monetary tightening coupled with rupee depreciation are expected to restore equilibrium to the current imbalances reflected in low domestic savings, high current account deficit and inflation. From a sectoral standpoint, in our view, post the correction the banking and infrastructure sectors are especially cheaply valued.

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