Asia Equity Focus Net foreign institutional investor flows drive Indian equities - Credit Suisse

Sensex is likely to be range-bound in the near term
The Sensex has declined by 10% year-to-date (YTD) in 2011. Net foreign institutional investor (FII) flows were a negative USD 657 million in Q1 2011. However, the sell-off in emerging markets witnessed a reversal around the end of March, leading to strong inflows into most of Asia, including India. With USD 1.5 billion of inflows each in March and April, the YTD figure on FII flows into India has turned positive at USD 480 million. As a result, the Sensex has rallied by more than 10% from its February low of 17,296. However, after the surprise 50 basis point rate hike by the Reserve Bank of India (RBI) and its hawkish comments on inflation, markets have given away most of their gains and are currently down 10% on a YTD basis.

Our structural view on Indian equities remains positive, with earnings growth together with the peak in inflation by the middle of year driving our 1-year Sensex target of 22,000. Our cautious near-term view drives our shorter-term trading band expectation of 17,500–20,000, given the macro headwinds facing India. We would therefore advise investors to add to their equity exposure closer to the lower end of our trading band, as valuations become appealing at those levels. Also given our expectations of high volatility in the market, an absolute return-oriented approach and active profit-taking on part of the portfolio would help to generate better returns compared to a passive buy-and-hold approach.

Our two key themes in the last six months have been companies with good earnings visibility and companies geared to benefit from the global recovery. While we would continue to focus on the former, some of the global recovery plays have seen a strong outperformance over the last few months. On the other hand, interest ratesensitive sectors have seen a healthy correction in an environment of policy tightening. As the Reserve Bank of India moves towards completing its tightening cycle later in the year, investors should watch out for domestic-oriented interest rate-sensitive companies or banks, whose valuations look attractive. Our favorite stocks are ICICI Bank (ICICIBC IN / IBN US, BUY), ITC (ITC IN / ITCG LX, BUY) and Reliance Industries (RIL IN / RIGD LI, BUY).