"We cut our Sensex earnings growth estimates from 10.5 per cent to 4.1 per cent for this fiscal and from 19 per cent to 12.7 per cent for the next. The new 12-month forward Sensex target is 18,200. Given the tail risks, we underscore our bear case-- a 14 per cent fall in the Sensex with a 35 per cent probability," Morgan Stanley India head Ridham Desai said in a note.
Citing the weakening macro fundamentals for the downgrade, Desai said: "We are trimming our broad market earnings growth forecast for FY14 to -6 per cent from 12 per cent and introducing an estimate of 5 per cent for FY15.
On the triggers for the market, he said that signalling has been a key issue for the market and said "the RBI needs to reaffirm that high rates will linger and the government needs to endorse fiscal consolidation."
He also warned that without credible policy measures, the market will be punitive with prices, especially the Indian rupee forcing macro rebalancing.
Equating the equity valuation template to the 1998 levels, he said a negative gap implies the market is not cheap though the P/B is in its bottom decile.
"The market is pricing in a six month forward of 9 per cent nominal IIP growth and a -5 per cent one-year forward earnings growth offering a 5.8 per cent risk premium.
For the domestic market, the key problem is that the US yields will keep real rates here higher for longer at a time when growth is already slowing, he concluded.