Earnings Upgrade required

* In our last Market Outlook report dated August 02, 2006, we had said that going ahead there would be two key positive triggers for the Indian equity market, viz a pause in the rate hikes by the US Federal Reserve (Fed) and better-than-expected earnings for Q1FY2007.

*The two triggers have played out as per our expectations and at the current level of 12,404 the Sensex has swiftly discounted both these positives, leaving very marginal upside.

* The Fed futures are indicating that any rate cut by the Fed can come in the first quarter of CY2007 at the earliest. This leaves us exposed to global economic risks in the interim six months.

* Corporate earnings haven't seen any significant upgrades over the last few months. Any upside from hereon would depend on the upgrades in the index' earnings driven by the better-than-expected Q2FY2007 earnings, especially in the banking and oil sectors.

*However, upgrades in the Sensex' earnings will have to be significant—in the range of 10%—to bring the market's valuations back to attractive levels. The Sensex is currently trading at 16.1x its one-year forward earnings, which is towards the higher end of the band in which it has usually traded, ie 12-16x.

* We continue to prefer domestic demand-driven stories like automobiles, banking, capital goods and cement.

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