Sell year-end rally; tough markets over next six months; expect index to correct to 14,500

India has been the worst-performing market this year, falling a third in US$ terms. Peaking inflation and a consequent pause in RBI rates are a positive which will likely help the traditional December rally. However, we continue to expect a tough market over the next six months and expect a correction of the Sensex to 14,500 as growth concerns take center-stage:

1. GDP growth to slow; downgrades likely:
We expect FY13 GDP to slow to 6.8% and consensus to cut GDP forecasts over the next few months. GDP growth in the next few quarters is likely to come even lower at around 6.5%. A slower GDP will be led by: (a) a slowing global economy, (b) impact of high rates and (c) slowing investment spend.

2. Earnings downgrades to continue:

We continue to expect earnings downgrades, led by slowing sales and sustained margin pressure from rising labor and interest costs. We expect the bottom-up Sensex EPS of Rs1,275 to be downgraded to Rs1,200 (growth of under 10% vs. expectations of nearly 15%).

3. Valuations will see slight de-rating:
Based on analysts' forecasts, markets at 13x one-year forward PE are at a slight discount to long-term averages. Slow down in GDP and earnings growth as well as falling RoEs will likely lead markets to trade lower.Secondly, on a relative basis, India trades at a 27% PE premium to GEM markets, higher than a 10-year average of 17%.