>Almost Everybody Is Bearish (Morgan Stanley)

Almost Everybody Is Bearish

1. Conclusion: The consensus is very cautious on India.
2. This is not just anecdotal but is evidenced by four solid indicators, i.e. market breadth, trading volumes, realized volatility and VaR.
3. Even though valuations are pointing to a sizeable downside risk with a high probability, such a correction is unlikely to be deep enough until these sentiment indicators inflect toward a more euphoric state.
4. What's New: Investors seem to lack conviction in Indian equities even as they stay invested given fund inflows.
5. Foreign portfolio flows into India have slowed down and domestic funds seem to be piling up cash.
6. More pertinently, market breadth has been weak since July 2005 and, has only recently shown signs of a recovery.
7. Trading volumes remain tepid, not suggestive of a boom in equity markets.
   
8. Significantly, realized volatility and VaR are at levels which are associated with positive rather than negative stock returns. While intra-day volatility has risen in recent weeks, it remains below historical average.
   
9. That said, the MSCI India’s trailing P/E is at 23.5, which historically is a level from where the market hasreturned an average fall of 26% in the subsequent year with a 90%+ probability.

Implications:

1. Even as investors seem cautious driven by the state of fundamentals, there does not seem to be enough recognition of the gains India has accrued from high global risk appetite.
   
2. For any compression in equity values, a flux in risk appetite is necessary. From a timing perspective, an upshot in breadth, VaR, realized volatility and trading volumes may be good signals for a reversal in market performance.

MORGAN STANLEY RESEARCH