Merrill Lynch has also noted the sharp contrast between the high inflation and the rising current account deficit in India and the falling interest rates and strengthening currencies in the rest of Asia.

The report also notes that with the revision of the structure of the BSE index, including software stocks in it in the process, a "drastic improvement" is expected in EPS growth for the sensex, and with valuations appearing attractive, may help improve the sentiment slightly.

The recent second quarter results of companies again highlighted the dichotomy in the economy-while sectors such as consumers, pharmaceuticals, oils, telecom and software showed healthy growth, commodities and engineeringcompanies continued to face slower demand and shrinking margins, says the report.

The report also notes that sentiment towards South-East Asian countries, which had suffered over the past 12-15 months, is likely to remain positive over the next few months as the interest rates fall, current accounts become positive and currencies strengthen.

The report says that the concern over the health of the UTI persists among investors despite attempts by the government to convey their support to the scheme. As a confidence-boosting measure, the UTI has announced a repurchase price in November and December, says the report.

The report says that the success of the governments's disinvestment programme will remain the key to meet fiscal objectives. The revenue shortfall and efforts to control fiscal deficit may lead to cut in government expenditure which could further affect performance of the investment-related sectors, says the report.

While the government is keen to provide a thrust to infrastructure sector,investments will feed into performance only after one year. Hence, Merrill Lynch continued to underweight sectors like cement and steel.

The report says that an improvement in the occupancy rate in October has led to outperformance of the hotel sector. However, given the cost cutting exercise at most corporates, Merril Lynch remain cautious on any sustained increase in occupancies and would advise profit-booking on every rise.