India Strategy Report by ABN Amro

Turning cautious
The BSE Sensex has surged 25% since January 2006, with most of the gains coming over the past month. We believe valuations are excessive and see signs the market is becoming overheated. Weadvise investors to take profit.

The Indian market looks overvalued by around 10%

We were quite bullish about the Indian market at the beginning of the year, andmaintained our view after the announcement of the 2006 Budget. However, the BSE Index has surged 25% since January 2006, with most of the gains coming over thepast month. We continue to be upbeat on India as a solid investment story over thelong term, but think a near-term correction should be just around the corner. Webelieve long-term investors should stay invested. We believe the market has nowreached a stage where valuations are looking excessive, and see signs that themarket is becoming overheated. We believe the BSE Sensex is overvalued by around 10%, and estimate current fair value for the index should be around 10,881 -implying the market will likely move in line with expected earnings growth of 15-17%for FY07F. The market seems to have been rerated sharply with no significant changein macro fundamentals over the past month. We believe valuations now discount partof the FY08 forecasts. However, we see little potential for significant earningsupgrades for FY07 and FY08.The market could correct or move sideways Excluding ONGC and Reliance, the BSE Sensex is trading at a PE of 21.4x FY07F and17.9x FY08F. This looks expensive considering earnings growth (excluding ONGC and Reliance) of 23% for FY07F and 19% for FY08F. The 10-year bond yield is 7.5% currently and interest rates have hardened over the past few months. New issues inthe IPO market are priced aggressively, in our view, leaving little room for investors to make money. Our other concerns are firming up of metal prices and a possible increase in oil-product prices after the state elections. We see room fordisappointment, unless there are significant earnings upgrades to support the rapidupswing. FII flows seem to have rerated the market, which we believe is not backedby significant earnings upgrades. We advise investors to wait for FY08 earningsvisibility to improve before making fresh commitments.Model portfolio and top picks – move to defensivesWe downgrade the auto sector to Neutral (from Overweight), as share prices haverallied sharply since the beginning of the year. We raise our weighting on pharma andmaintain Overweight on IT. We increase our weighting on ONGC, given its underperformance year to date and we believe the negatives are mostly discounted.We have added Glenmark Pharma and HPCL in our model portfolio. Our top picks are BHEL, TCS, Infosys, Dr Reddy’s Labs, Tata Motors, Bharti Televentures, Grasim, UTIBank, and HDFC.
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