Fw: Market Outlook: 2011: Another year of modest returns

Market Outlook [January 06, 2011]  Sharekhan www.sharekhan.com Summary of Contents MARKET OUTLOOK 2011: Another year of modest returns Key points Volatility driven by global imbalances: 2011 is likely to be another year of divergence. On the one hand, most of the developed economies continue to struggle with sluggish growth (and the threat of disinflation). On the other hand, the emerging markets are having to grapple with inflationary fears led by spiraling commodity prices (induced by successive quantitative easing [QE]) and overheating of economies. Within the developed world, the US recovery is likely to gain ground whereas Europe would continue to be the dark spot and one of the key reasons for risk aversion-driven bouts of volatility in the equity markets globally.  India?chugging along but macro headwinds emerge: The Indian economy has shown a strong revival largely on the back of a resilient domestic consumption-driven demand. The economy has grown the fastest (8.9% in Q2FY2011) in the last eleven quarters led by a revival in the agricultural and manufacturing sectors. Going ahead, the anticipated revival in infrastructure investments is also likely to boost the overall economic growth in the country. However, the macro environment is punctuated by stubbornly high inflation, spiraling commodity prices, rising twin deficits and stressed liquidity conditions. Earnings momentum to sustain; little scope for multiple expansion: Consensus estimate shows that the cumulative earnings of the Sensex companies are expected to grow at a healthy rate of 20% (+) in FY2012. However, the macro headwinds in the forms of rising cost (spiraling commodity prices and wage inflation) and tight liquidity are the potential risks to the earnings momentum and could also limit any possible re-rating of the equity markets (ie price-earnings multiples).  Returns in line with 2010 but with higher volatility: During 2010, the markets remained range-bound in the first half and gained momentum in the second half on account of improvement in economic conditions, spike in foreign inflows and positive global cues. However, given the macro headwinds locally, there is a growing consensus that the market would be more volatile in 2011 as compared to 2010. Assuming that the Sensex manages to sustain the current multiples, the benchmark indices are likely to give returns of around 15-20% in 2011, largely driven by a growth in the earnings. Investment themes?avoid rate sensitive sectors; play selectively on consumption; positive on IT services and infrastructure/capital goods sectors: In the evolving scenario the rate sensitive sectors are likely to underperform (at least in the first half and provide good entry points for the patient investors). The domestic consumption story has played out well in the past few months and it is time to be selective. Among the domestic consumption-driven sectors we prefer those with high operating leverage, like retail and hotels. The risk-reward ratio appears favourable for the late cycle movers like capital goods and infrastructure companies as the investment cycle is expected to pick up in this year. In our view, the information technology (IT) sector will outperform on the back of a revival in technology spending in the USA which will benefit the larger IT players (Infosys Technologies, Wipro). Notwithstanding the concerns related to attrition and wage inflation, we also have a contrarian bullish stance on the mid-cap IT companies due to their attractive valuations. As a hedge against the possible commodity price-driven inflationary environment, a few stocks in the upstream segment (Cairn India, Selan Exploration) and in the metal sector could do better than the benchmark index in 2011.   Click here to read report: Market Outlook     Regards, The Sharekhan Research Team myaccount@sharekhan.com