Index target 23,500

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SummaryTaper fears, poll euphoria and economic realities

Over the past few months, the market has recovered sharply from its lows as concerns over tapering in the US have eased and the market is focused on a possible strong showing by the Modi-led BJP in the general elections in the May 2014 elections.

In our view, politics in India and Fed tapering will be the focus of the markets in 1H14 and will overshadow the economy and earnings that drive long-term market performance. For 2014, we have an index target of 23,500 based on 15x 1-year forward earnings.

#1: Taper to drive correction in early 2014

In our view, three factors will likely drive a correction in markets in early 2014 to 19,000-19,500 levels:

a) Tapering by the US Fed.

b) Supply of paper Ė the government needs to raise $6 bn in equity by March 2014 to meet its disinvestment targets.

c) Rate hikes and sluggish December quarter earnings.

Fed may taper early 2014

For the past few years, global markets have been characterised by a high-liquidity, low-growth regime. This will probably change to a higher growth and lower liquidity environment, in our view. The market impact of this change was seen in June 2013, when fears of the US Fed reducing its monthly purchases of Treasuries and Mortgage Backed Securities (MBS) led to a sell-off, especially in the emerging markets (EMs). The markets rebounded sharply when the Fed decided to defer tapering.

Our US economist, Ethan Harris, believes the decision on tapering will be data-dependent. His base case is of a March tapering, but he now believes that there is a 15% chance of a Dec 2013 tapering, 30% chance of a Jan, 2014 tapering, 35% chance of a March tapering and a 20% probability that it is after March.

So what will be the impact of tapering on India?

We make three points:

a) Longer term, we believe tapering will have limited impact on markets and the economy. In fact, if the US economy improves (which is why the Fed is tapering), it may help the Indian economy and markets.

b) However, near-term the markets will likely correct given concerns of reducing liquidity while the benefit of a stronger US economy will be felt only with a lag. Given the strong rally (near 20%) in the market over the past 15 weeks, the fears of tapering will provide an excuse for the correction Ė the market could drop to the 19,500 levels, in our view.

c) We do

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