organ Stanley-Sell-Off in Mumbai, Sharp and Sweet

Morgan Stanley
Rally Likely to Snap

• Macro slips: Over the past few days, the worst possible macro outcome for
India seems to be unfolding with a depreciating currency and stronger commodity
prices (notably oil). This macro outcome lends itself to higher inflation and
thus a tighter monetary environment and creates downside risk to growth.

• Sentiment and valuations off lows: The 15%-odd rise in the equity markets
from the March lows has pushed valuations and sentiment off the lows. While
sentiment is not even close to neutral levels and our composite valuation
indicator is 50% off highs, the market is no longer in fear territory.

Market breadth has advanced to a new peak and retail investor flows remain
strong. These components of the sentiment indicator point to possible areas of
risk for the market. We remain suspicious of the broad market performance,
especially in light of softening fundamentals and rich valuations.

• Earnings support is not so strong: 60 companies in our coverage universe
have reported earnings for the quarter ended March 2008, and 60% of these have
come in below our analysts’ expectations. The one takeaway from the season is
the year-on-year compression in EBITDA margins (170bp ex-Energy).

With margins at all-time highs, the risk on margins is quite evident and,
combined with slowing growth, is reason to believe that earnings may become
weaker in months ahead.

• Implications: The factors supporting a market rally (see Brace for a Bear
Market Rally, dated March 17, 2008) are no longer in play. Sentiment has
recovered, valuations are off the lows, and India has started to outperform
emerging markets.

The macro remains an important input and the trigger for a reversal in the
rally could be a falling rupee and rising commodity prices. From a sectoral
perspective, we continue to back Consumer Staples, Healthcare, Energy, and
Telecoms over Financials, Industrials, Consumer Discretionary, and Utilities.
Technology may give up some relative gains given the sheer strength in recent
performance

Rohit
9868245473