Morgan Stanley view on Market - ET

rokerage house JM Morgan Stanley Securities has estimated the fair value for the 30-share BSE Sensex around 11,500, but has warned that the index was likely to quote below this level as the fundamental picture appeared to be less rosy than before.

Morgan Stanley is advocating a portfolio that is biased in favour of defensive stocks, while it is advocating lower exposure to consumer cyclicals and stocks that are sensitive to interest rate changes. Late Friday, the Reserve Bank of India announced a two-phased hike in cash reserve ratio by 50 basis points to 6.5% and a hike in repo rate by 25 basis points to 7.75%. “As the market tries to forge ahead, we think it is more likely to encounter snakes that gulp it down to lower levels than arrows or ladders that propel it to higher levels.

In a tactical move, we are increasing the cash balance in our model portfolio, while trimming our position in the software services sector,” the Morgan Stanley note to clients said. Since touching fresh peaks in the second week of February, equities have been steadily losing ground despite the occasional pullbacks.

“ Anecdotally, investors seem complacent about the recent fall, having been burnt by their experience last year when they were caught being too bearish post the May 2006 fall,” the Morgan Stanley note said. “Second, the market faces several headwinds in the form of a weaker domestic demand outlook (heralded by higher interest rates), a relatively less docile political environment at home and uncertain prospects for global risk appetite. Last, neither fundamentals nor market technicals suggest that we are done with the correction,” the note added.

The brokerage opines that the key differentiating factor from the May 2006 crash is the combination of slowing domestic growth and a less favourable political environment (in view of the numerous elections ahead) this time around. “The market is trading at valuations that do not suggest positive returns, while fundamentals are looking less robust than before. India’s high and rising beta indicates heavy dependence on global factors for its immediate performance and global factors appear less predictable than before,” the note said, adding that such a situation was hard for a fixed bag of technical indicators to neutralise.

The brokerage has cited rising inflation as one of the main worries for the market. “In our view, the inflation problem is one of excess demand over supply and, with supply unlikely to be created quickly, demand needs to slow. The rise in rates over recent months should produce a lagged effect on India’s leveraged consumption-driven growth cycle,” the note said.

Morgan Stanley feels that in all probability, the forthcoming earnings season “will be good”. At the same time, the brokerage has cautioned that expectations continued to run high, “It is noteworthy that, for the first time in several months, the sell side consensus has been lowering estimates. We think earnings will turn distinctly weaker in the latter part of 2007 if the economy slows down as we are forecasting,” the note said.

Morgan Stanley also expects the return on equity of corporates to come under pressure. “The fact is that corporate India has upped the ante on adding assets to its balance sheet. This will have negative implications for asset turnover, especially if revenue growth slows,” the note said. “The other issue for investors to deal with is the slippage that we are witnessing in earnings quality. Thus the share of operating cash flow in net profit is at an eight-year low, suggesting that book entries may be shoring up reported earnings,” the note added.