Market Outlook

There is not only a crisis of credit but there is a crisis of confidence as well. The kind of economic
situation we are in is unprecedented since we saw in early part of the last century. In times like this,
historical records are broken and new ones are created. So, it might be ridiculous to make opinion on
the basis of past events. But we may attempt to gauge up the underlying situation. As they say
extraordinary problems require extraordinary solutions. And that we see in the depth and scale at
which governments and regulatory bodies are taking steps. To what extent they will be effective only
time will tell. Economic conditions at this juncture are very uncertain and unpredictable and the
direction of the future will depend much on the future events. In this backdrop we try to figure out how
the stock markets are going to behave in the next few quarters.

After three years of over 9% GDP growth, India’s growth rate is expected to moderate to a level
between 6.5-7.5% in the current fiscal. The World Bank has already revised China’s GDP growth to
7.5% from earlier 8.5% against previous years’ double digit growth. Though we are domestic economy
and we can grow on our own unlike China which contributes over 8.9% of world exports against ours
1%. Still, our export will be affected badly as developed economies like the US, Europe and Japan to
whom we mainly export, are in recession. Sectors that are likely to take big hit are IT, jewellery and
gems, textiles among others. Even emerging markets in Asia region are experiencing slowdown. We
are likely to see decent growth in top lines of India Inc but growth in their bottom lines will be muted.
Already there is expectation that the many frontliners will report single digit growth in net profit. Even
in FY10, picture is not rosy. The severity of the current economic crisis is not known and everybody is
groping and indulging in wild guesses. How the markets will move will much depend on future triggers
like corporate earnings, FIIs flows, global cues and political situation. Though RBI has taken steps to
ease the liquidity crunch by cutting rates and more are in the offing, and opening other windows such
as ECBs. But considering the faltering risk appetite and credit situations, it will be very difficult for
corporate India to raise money. FIIs’ return to the Indian equities is necessary for them to bounce
back.

When the markets will bottom out?

We believe markets will bottom out by the end of this fiscal. However, we are likely to see a long
consolidation period which may last for 18 months. Some experts argue that we are about half-way
between a smaller bottom and a mega-bottom. They expect a further correction of 21-25% correction
for S&P500 and Dow and predicting them to test levels as low as of 700 and 6,500 respectively. From
that yardstick, Sensex may test 6,800-7,200 levels. The good news is that after both mega-bottoms in
the 1974 and 1982, the stock market promptly returned at least 60% in the next 9 months. But will that
happen this time in 9 months or 18 months is anybody’s guess.

What level the Sensex will be at by the end of FY09 and FY10?

Despite the fact that we are second fastest growing economy our economy is not insulated. Indian
stock markets move in tandem with its global peers. On estimated Sensex EPS of 900 and a PE of 8x
(the most pessimistic approach; Sensex has never traded below a PE of 8x) we see Sensex at 7,200.
A more optimistic level of 10,800 can be seen at PE of 12x). Our sense is that the Sensex will trade
range bound till March 2008 in between 7,000-9,500 while Nifty will gyrate between 2000-2900 in the
above said period. By the end of FY2010, we see Sensex touching 15120 at PE of 15x.

Deepak Tiwari
Research Analyst

deepakt@arthamoney.com

T: + 91 22 4063 3032

Dec 1, 2008 For Private Circulation only 1

 Since January’s peak, Sensex has lost over 57%. In the last one month itself it has lost over 15%.
Stocks across the sector have been the victims of global turmoil. The kind of volatility is seen these
days are unparalleled as captured by India VIX data which has been continuously rising; it has surged
to 65.6 from 24.2 since May 2008. FIIs are incessantly cash out from the Indian equities in order to
make up for the losses incurred back home. The recent trend is that both the FIIs and Domestic
Institutions are net sellers while retail investors are holding the fall to some extent. In last one month,
FIIs stood net sellers with Rs. 6,462 crore followed by DIIs with Rs. 135 crore. Retail investors on the
other hand, were net buyers with Rs. 2,520 crore. Volumes in both cash as well derivatives segments
are declining rapidly. The average cash turnover of Rs 5,049 on BSE and Rs 12166 crore on NSE
respectively since May 2008 has continuously been declining. During last one month it was Rs. 3701
crore and Rs 9751 crore on BSE and NSE respectively. A similar trend is witnessed in derivatives
segment on NSE as well save spikes during expiry days.

What good is happening?

 Inflation and prices of commodities including crude have drastically declined in the couple of
months leaving enough room for the RBI to take steps to stimulate the economic growth.

 Interest rates are likely to come down soon which will generate liquidity and boost demand.

 Government’s stimulus plans like increased spending, tax cuts and priority on infrastructure
funding will shore up the growth.

 Domestic institutions that are sitting on the huge cash, will aggressively invest soon.

 Due to cooling off crude prices and start of gas flows from new blocks such as Jharia block
in Jharkhand and D6 gas block in the eastern offshore KG Basin will improve fiscal position.

 Real estate prices are likely to correct sharply as demand weakens. We expect at least 20-
25% correction in property prices which have gone up almost thrice in most markets in the
past five years.

 At rock bottom prices there are huge opportunities for investors with long term horizon.

What is bad for the markets?

 Capital requirements for expansion particularly imported capital (such as ECBs), will take a
hit due to global credit crunch, increased risk aversion and increased cost funds.

 Tepid corporate earnings are expected in coming quarters as slowdown fears loom large.
The bottom line growth is likely to hit single digit.

 FIIs flow is unlikely to resume in near term thanks to increased risk aversion and high
volatility in rupee. A weak rupee and expectation of poor corporate earnings are other main
reasons of capital flight. We expect FIIs exodus will continue at least till December end. Post
the year end when new allocations happen in January, some of them may return to the
Indian bourses but it is too early to say that by that time risk appetite will resume.

 Economic data will decide the future direction of the markets such as IIP, corporate
earnings, quarterly GDP growth, export growth etc.

 Depreciating rupee will increase the cost of import which will further hit the expansion plans
of India inc. As per recent reports, in the last H1 FY09, 92 projects amounting to Rs. 76,529
crore have been shelved hitherto.

 Exports to take a big hit. The IMF expects the world trade growth to decline to 4.1% in the
current fiscal against 4.9% a year ago. The growth rate was 7.2% in 2007 which shows
imminent slowdown. Developed economies are in recession. India’s biggest trade partner,
China’s growth has been scaled down significantly from double digit to 7.5% this fiscal. It will
force India to focus on Asian markets but these markets cannot make up for developed
markets. Needless to mention that this will hit India’s exports which is evident by October’s
figures. Exports grew at 15% in October and this is the lowest growth rate in five years.
During April-September export grew at the rate of 30.8%, and 21. 9% during April-October.
Sectors that will be badly affected by the current economic crisis will be IT and ITES, gems
and jewellery, automobile parts, textile and capital goods. Seven key export segments—
textiles, apparel, gems and jewellery, diamonds, brassware, handicraft and leather—all are

Dec 1, 2008 For Private Circulation only 2

 reeling under recessionary trends.

 Tax collections have already taken a big hit thanks to slowdown in the production and
demand. Excise collections in October dipped by 8.7%, after a 3.8% dip in September.
However, net direct tax collections during April-October this fiscal stood at Rs.1.67 trillion, up
from Rs.1.29 trillion, registering a growth of 29.5%. Growth in corporate taxes was 33.5%,
while personal income tax grew at 23.1%. Any tax cut will further widen fiscal deficit which is
a major concerns for the overseas investors.

 Terrorist attacks like we recently saw in Mumbai, the financial capital of the country, will dent
the India’s image of a safe investment destination and expose its vulnerability to such
attacks. In short term it will affect sectors like hospitality and tourism.

 In the first half of the next year, India will go for election and thus we cannot expect any
major policy reform and announcement. Further, a hung parliament will increase the political
uncertainty and markets will respond to that in the similar fashion.

When the markets will bottom out?

Stock market is a discounting mechanism. When the stock market recovers, normally the economy
will follow in six to nine months. All the bad news has already been discounted into the current stock
prices and unless markets encounter some unexpected shocking news, we believe markets will
bottom out by the end of this fiscal. However, we are likely to see a long consolidation period. Some
experts argue that we are about half-way between a smaller bottom and a mega-bottom. They expect
a further correction of 21-25% correction for S&P500 and Dow and predicting them to test levels as
low as of 700 and 6,500. From that yardstick, Sensex may test 6,800-7,200 levels. The good news is
that after both mega-bottoms in the 1974 and 1982, the stock market promptly returned at least 60%
in the next 9 months. This also happened after the 1932 bottom within the Great Depression. So, can
we expect such sparkles in the next year end? It’s anybody’s guess. But it must be worth to mention
that the time period between bottoms can be irregular, sometimes, with over a decade passing
between them. The deepest correction took place in 1974 and 1982. Our expectation is that we are
likely to see a long consolidation period which may last for 18 months.

What level the Sensex will be at by the end of FY09 and FY10?

"We know what we are, but we know not what we may become" William Shakespeare said. Meaning
thereby future is very uncertain and unpredictable. Despite the fact that we are second fastest
growing economy our economy is not insulated. Indian stock markets move in tandem with its global
peers. On estimated Sensex EPS of 900 and a PE of 8x (the most pessimistic approach; Sensex has
never traded below a PE of 8x) we see Sensex at 7,200. A more optimistic level of 10,800 can be
seen at PE of 12x). Our sense is that the Sensex will trade range bound till March 2008 in between
7,000-9,500 while Nifty will gyrate between 2000-2900 in the above said period. By the end of
FY2010, we see Sensex touching 15120 at PE of 15x.

FY 2008 Today 2009E 2010E

PE 20.11 9.9 8 12 15 15
EPS 778 878 900 900 900 1008
Sensex 15644 8696 7200 10800 13500 15120

Dec 1, 2008 For Private Circulation only 3

Sensex Cash Turnover in Rs. crore since May 2008 NSE Cash Turnover in Rs. crore since May 2008

8000 25000
Sensex Cash 5d avg NSE Cash 5d avg
7000

20000
6000

5000
15000

4000

3000 10000

2000

5000
1000

0
8-May
16-May
27-May
4-Jun
12-Jun
20-Jun
30-Jun
8-Jul
16-Jul
24-Jul
1-Aug
11-Aug
20-Aug
28-Aug
8-Sep
16-Sep
24-Sep
3-Oct
14-Oct
22-Oct
3-Nov
11-Nov
19-Nov

7-Oct
16-Oct
24-Oct
5-Nov
13-Nov
2-Jul
10-Jul
18-Jul
28-Jul
6-Jun
16-Jun
24-Jun

5-Aug
13-Aug
22-Aug
1-Sep
10-Sep
18-Sep
26-Sep
2-May
12-May
21-May
29-May

Total Cash Turnover in Rs. crore since May 2008 Derivatives Turnover in Rs. crore since May 2008

30000 90000
Total Cash Turnover 5d avg NSE Derivatives 5d avg

80000
25000
70000

20000 60000

50000
15000

40000

10000
30000

20000
5000

10000

0
0
7-Oct
16-Oct
24-Oct
2-Jul
10-Jul
18-Jul
28-Jul
6-Jun
16-Jun
24-Jun
2-May
12-May
21-May
29-May

5-Nov
13-Nov
5-Aug
13-Aug
22-Aug
1-Sep
10-Sep
18-Sep
26-Sep

7-Oct
16-Oct
24-Oct
5-Nov
13-Nov
2-Jul
10-Jul
18-Jul
28-Jul
6-Jun
16-Jun
24-Jun

5-Aug
13-Aug
22-Aug
1-Sep
10-Sep
18-Sep
26-Sep
2-May
12-May
21-May
29-May

Dec 1, 2008 For Private Circulation only 4

 20-Nov
20-Nov

5
5d avg

19-Nov
19-Nov
Derivatives Turnover in Rs. crore in last one month

18-Nov
5d avg
NSE Cash Turnover in Rs. crore in last one month

18-Nov
17-Nov
17-Nov
14-Nov
14-Nov
13-Nov
13-Nov
12-Nov
12-Nov
11-Nov 11-Nov
NSE Derivatives

10-Nov 10-Nov
7-Nov 7-Nov
6-Nov
NSE Cash

6-Nov
5-Nov 5-Nov
4-Nov 4-Nov
3-Nov 3-Nov
31-Oct 31-Oct
29-Oct 29-Oct
27-Oct 27-Oct
24-Oct 24-Oct
23-Oct 23-Oct
22-Oct 22-Oct

For Private Circulation only

21-Oct 21-Oct
14000

12000

10000

8000

6000

4000

2000

60000

50000

40000

30000

20000

10000

0
20-Nov 20-Nov
Sensex Cash Turnover in Rs. crore in last one month

5d avg

19-Nov

5d avg
19-Nov

Total Cash Turnover in Rs. crore in last one month

18-Nov 18-Nov
17-Nov 17-Nov
14-Nov 14-Nov
13-Nov 13-Nov
12-Nov 12-Nov
11-Nov 11-Nov
10-Nov 10-Nov
Sensex Cash

Total Cash
7-Nov 7-Nov
6-Nov 6-Nov
5-Nov 5-Nov
4-Nov 4-Nov
3-Nov 3-Nov
31-Oct 31-Oct
29-Oct 29-Oct
27-Oct 27-Oct
24-Oct
24-Oct
23-Oct
23-Oct
22-Oct

Dec 1, 2008
22-Oct
21-Oct
21-Oct

18000

16000

14000

12000

10000

8000

6000

4000

2000

0
0
6000

5000

4000

3000

2000

1000
 0
10
20
30
40
50
60
70
80
90
0%
50%
100%
150%
200%
250%
2-May-08
12-May-08 2-May
21-May-08 12-May

Dec 1, 2008
29-May-08 21-May since May 2008
6-Jun-08 29-May
16-Jun-08 6-Jun
24-Jun-08 16-Jun
2-Jul-08 24-Jun
10-Jul-08 2-Jul
18-Jul-08 10-Jul

India VIX
28-Jul-08

% Change
18-Jul
5-Aug-08 28-Jul
13-Aug-08
Total Cash

Volatility as reflected in VIX data

5-Aug
22-Aug-08
13-Aug
1-Sep-08
22-Aug
10-Sep-08
1-Sep
18-Sep-08
10-Sep
26-Sep-08
18-Sep
7-Oct-08
26-Sep
16-Oct-08
7-Oct
24-Oct-08
16-Oct
4-Nov-08
24-Oct
Derivatives

12-Nov-08
5-Nov
Relative change in Total Cash and derivatives Turnover

13-Nov

0
20
40
60
80

-60
-40
-20

-1500
-1000
500
1000
1500

-500
0
100%
120%
140%

0%
20%
40%
60%
80%

21-Oct 2-May

For Private Circulation only

22-Oct 12-May
23-Oct 21-May
since May 2008

29-May
24-Oct
6-Jun
27-Oct
16-Jun
28-Oct
24-Jun
29-Oct
2-Jul
31-Oct 10-Jul
3-Nov 18-Jul
4-Nov 28-Jul
FIIs activities in last one month

5-Nov 5-Aug
6-Nov 13-Aug
Cash

7-Nov 22-Aug
10-Nov 1-Sep
11-Nov 10-Sep
12-Nov 18-Sep
14-Nov 26-Sep
17-Nov 7-Oct
18-Nov 16-Oct
19-Nov 24-Oct
5-Nov

6
Market Cap

20-Nov
21-Nov 13-Nov
Relative change in Cash Turnover and Sensex market cap
DIIs activities in last one month Retail investors’ activities in last one month

800 1000.0

800.0
600
600.0

400 400.0

200.0
200

0.0

0
-200.0

-200 -400.0

-600.0
-400
-800.0

-600 -1000.0

21-Oct
22-Oct
23-Oct
24-Oct
27-Oct
28-Oct
29-Oct
31-Oct
21-Oct
22-Oct
23-Oct
24-Oct
27-Oct
28-Oct
29-Oct
31-Oct
3-Nov
4-Nov
5-Nov
6-Nov
7-Nov
10-Nov
11-Nov
12-Nov
14-Nov
17-Nov
18-Nov
19-Nov
20-Nov
21-Nov

3-Nov
4-Nov
5-Nov
6-Nov
7-Nov
10-Nov
11-Nov
12-Nov
14-Nov
17-Nov
18-Nov
19-Nov
20-Nov
21-Nov
Sensex EPS since FY2001-2010

1200

1008
1000
900

778
800

643

600 539

416
400
301
230
193 204
200

0
2009E

2010E
2001

2002

2003

2004

2005

2006

2007

2008

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Dec 1, 2008 For Private Circulation only 7