1 Page Morgan Stanley Investment Management Morgan Stanley Mutual Fund March 2010 Current Equity...

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Morgan Stanley Investment Management

Morgan Stanley Mutual Fund

March 2010

Current Equity Market and Post Budget Scenario

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Budget 2010 Highlights

Fiscal consolidation.

Change in Income Tax Structure

2% increase in excise duties across the board, plus the increase in import tariff and prices of petroleum products could lead to inflation.

The move to re-capitalize public sector banks and induce more competition by giving banking licenses to private sector and NBFC’s.

The finance bill seeks to bring down the fiscal deficit to 5.5% of GDP by FY11 and more importantly lay down road map for the next two years, to bring it further down to 4.1% of GDP by FY 13.

This should boost consumption, particularlydiscretionary spend items and benefit sectors such as housing, autos, retail and others.

While inflation may remain high for sometime, higher non food inflation will be balanced by lower food inflation on account of softening of food prices.

Capital infusion to strengthen the banking system so that it can stimulate economic growth by supplying credit.

Impact

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Infrastructure thrust to continue

Auto Sector

Pharma Sector

Energy

Allocation for infrastructure continues to remain high - positive for Infrastructure sector companies.

Excise Hike and Increase in Fuel Prices to be offset by increase in disposal income – Thus no adverse impact on demand

An increase in weighted deduction in R&D, a lowering of the surcharge on income tax, higher expenditures for healthcare infrastructure, and no increase in excise duty will be a beneficial move across the sector.

5% Import duty on crude (Nil earlier), Increase in import duty on Petrol and Diesel from 2.5% to 7.5% –Negative for OMCs. Excise duty on Petrol and Diesel has gone up by Re. 1/litre is inflationary.

Budget 2010 Impact on Key Sectors

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• Prospects of high inflation in 2010 on the

back of high food & commodity prices

• Valuations no-longer cheap, significant risks

remain as the recent rally has taken valuations

back above their long term averages

• Correction in global equity markets,

particularly USA and China

Indian Equity Markets: Current Scenario

• Improvement in sentiments and

risk-appetite globally

• Better than expected economic data

supporting the view of global recovery

in 2010 and faster growth in India

• Enthusiasm coming in from government

reforms, growth oriented policies

• Corporate earnings picking-up on

back of improvement in economic activity

Current rally has build-up on Risk Factors

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0

5000

10000

15000

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25000

Jul-

07

Au

g-0

7

Se

p-0

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-07

No

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De

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7

Jan

-08

Fe

b-0

8

Ma

r-0

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Ap

r-0

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Ma

y-0

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-08

Jul-

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g-0

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Se

p-0

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Oct

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No

v-0

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De

c-0

8

Jan

-09

Fe

b-0

9

Ma

r-0

9

Ap

r-0

9

Ma

y-0

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Jun

-09

Jul-

09

Au

g-0

9

Se

p-0

9

Oct

-09

No

v-0

9

De

c-0

9

Jan

-10

Budget F2009

AIG is bailed out

Lehman brothers files for bankrupty

Bank of America acquires Merill lynch

Financial bailout package approved by the US

Inflation hits a 16 year high, at 12.91%

Satyam receives letter from chairman tendering resignation and detailing financial irregularities

S&P revises India outlook to Negative

Geithner Plan is announced

Congress sweepsthe Lok Sabha polls

G20 announces USD one trillion stimulus

Terrorist attack in mumbai

Commodities Bubble – Crude Oil hits all time high

Global Equity sell- off

Union Budget F2010

Food inflation at a multiyear high

ACE Fund Launched

US sub prime crisis - Six sigma event

Dubai Debt restructuring

10 yr bond yield at 14 mth High

RBI raises SLR rate from 24% to 25%

IIP 11.7% YoY - Nov 09 (vs 10.3% YoY in Oct 09)

Post recovery in 2009 equities remain in consolidation phase

Source: Morgan Stanley

BS

E S

EN

SE

X

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Indian equities have delivered attractive returnsover the long term

Source: Bloomberg

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1000

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y-07

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y-08

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g-0

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No

v-08

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b-0

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Ma

y-09

Au

g-0

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No

v-09

Best returns in the early part of bull run

5 Yrs Returns = 24% CAGR

3Yrs Returns = 40% CAGR

Nift

y

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The market performance in 2009-10 seemed to be tracking what we experienced in 2003-04…..

Source: Morgan Stanley Research

Are we at the beginning of a new bull phase for equities ?

An outcome similar to 2003-2004 was quiet evident in 2009 and the current rally could extend for a medium to long term period from now.

100

120

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

2009

2003

MSCI India Index (Rebased)

Months Post Market Bottom

2004

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80

100

120

140

160

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200

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

G-5: Narrow Money as a share of GDP BRICs

Global Economic Themes for 2010

Central banks to crawl rather than rush towards the exit, so global liquidity continues to be ample, abundant and augmenting.

‘AAA liquidity cycle’ remains intact


‘BBB G10 recovery’: Bumpy, Below-par and Boring

Growth in EM (6.5%) becomes more balanced and will by far outpace growth in the G10 (2%).

-6

-4

-2

0

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8

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Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10

G10 GDP YoY EM GDP YoYMS Forecasts

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Indian Economy to sustain +7% real GDP growth for next few years

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009E

2010E

2011E

Global GDP Growth India GDP GrowthIt is expected that the global GDP growth rate would revive back to the 3% mark in the next 2-3 years and the Indian GDP growth on the back of global revival would scale up to the 7% mark.

A tale of two worlds…..

Source : Morgan Stanley Research Estimates

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Jul-0

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Seasonally adjusted IIP w as largely f lat betw een March 2008 and March 2009

Trends in Industrial production indicating sharp uptick in economy

Industrial production (IP) growth accelerated to 11.7%YoY in November 2009, highest in two years.

India has surprised on domestic demand with almost a vertical rise in IP in the last few months after remaining largely flat between March 2008 and March 2009.


Vertical rise in IP from May 09

0%

3%

6%

9%

12%

15%

18%

Jan-

02

Aug

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Jul-0

5

Feb

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Sep

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Apr

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Jan-

09

Aug

-09

YoY% YoY%, 3MMA

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Corporate earnings are back in positive, exhibiting growth

Source: CLSA Asia – Pacific Markets

34

47

28

35

30

24

41 41

32

2117 16

2328

44

3134

27

21

1512

9

(5) (6)

12

4

16

(20)

(10)

0

10

20

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1Q04

2Q04

3Q04

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4Q09

1Q10

2Q10

3Q10

YoY change in Sensex Free Float PAT (%)

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BSE Sensex earnings growth to compound at 18% annually to F2012

Source: Morgan Stanley Research as of Jan 10

BSE Sensex consensus EPS growth

-5%

0%

5%

10%

15%

20%

25%

Aug

-07

Oct

-07

Nov

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Jan-

08

Mar

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Jun-

08

Jul-0

8

Sep

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Dec

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Feb

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Apr

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Jul-0

9

Aug

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Oct

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Dec

-09

Jan-

10

F2010E EPS - 899 F2011E EPS - 1096

F2012E EPS - 1294

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3.8

4.7

3.0

1.2

2.2

3.2

4.2

5.2

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

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Jan

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Jan

-08

Jan

-09

Jan

-10

15 Year Average 2.6x

24.6

16.0

8.37

12

17

22

27

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

15 Year Average 14.3x

Valuations close to long term averageSENSEX P/E (x)

SENSEX P/B (x)

The Sensex’s current one year forward P/E is 16x.

The Sensex’s current one year forward P/B is 3x.

Source: Motilal Oswal

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Equities finish the decade as the best asset class and may continue to outperform

Post Tax Returns %

Asset Class 5 Yr CAGR

Volatility in annual returns

10 Yr CAGR


15 Yr CAGR


Gold 19.5 4 13.1 8.9 8.8 8.4

10 year treasuries 4.4 0.1 6.5 0.8 5.9 2.1

Bank Fixed Deposit 5.2 0.9 4.8 1.1 5.4 2.1

Property (across 7 cities) 21.1 19.9 12.3 15.9 7.1 16.8

Equities (BSE Sensex) 23 50.2 15.2 43.7 12.2 40.1

5Y Returns: Gold Sparkles on a Risk-adjusted basis

15Y Returns: Equity at the top, Property at the bottom

Source: Bloomberg, Morgan Stanley Research

Over the past 5, 10 and 15 years equities has been the best performing asset class in India. Surprisingly, property was the worst performing asset class for the 15-year period.

Asset Class Returns as on Dec 2009.

Assumption:10-year treasuries: For the return from 10-year treasuries, we assumed that the annual coupon was reinvested in one-year bank deposits post the payment of tax at the marginal tax rate.Bank FD: The bank fixed deposit return is the sum total of returns in annual bank fixed deposits together with the return on the reinvestment of post-tax interest earned on the deposit. The tax rate used is the marginal tax rate for individuals.Gold: The return on gold is the delta in the domestic gold price, which is determined by the import tariff on gold, the exchange rate and the global gold price.Equities: For equities, we have taken the BSE Sensex as the proxy for returns and reinvested post-tax dividends into the Sensex.Property: For measuring return on property, our sample consists of residential properties in various localities across seven cities (Mumbai, Bangalore, Delhi, Kolkata, Ahmedabad, Pune, and Chennai). The gains on property, equities and gold are reduced by the long-term capital gains tax of 10% at the end of the period.

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Attractive Medium to Long Term Outlook for Equity Markets

Sustaining

strong corporate

earnings growth

Rise in risk appetitive

globally on back of improved economic conditions

Stable Government,

Economic reforms

Massive

pent-up

demand for

infrastructure

spending &

consumption

Equities to

deliver above

average returns

Positive sentiment of FIIs towards Emerging

Markets & India

Stable government, Economic reforms

One of the

fastest growing

economies in

the world, averaging

7% GDP

growth

Double Digit Income

growth drivingconsumption

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