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f the 45 listed companies under Bahana's coverage (75 percent of the Indonesia Stock Exchange's total market capitalization), 14 companies have not reported their second quarter financial results. Six companies are undergoing limited review, and in accordance with capital markets regulation, have until the end of August to report.

Thus far, the market as a whole has booked a second quarter operating profit growth of 13.7 percent, down from 15.3 percent recorded in the first quarter.

Once the rest of the companies report their earnings, we believe growth rate in Q2 will further weaken because many of these companies are dollar earners, and do not benefit from the strength of the rupiah.

However, the Q2 net profit growth for the market has so far accelerated to 20.2 percent on foreign exchange gains, from 13.9 percent in Q1. Going forward, we expect some weaknesses in Q3 results to persist for banks and commodity-related sectors.

Meanwhile, the Jakarta Composite Index (JCI) has risen 71 percent this year-to-date, making Indonesia the second best performing market in the region. This has driven valuations to price to earning (PE) ratio of 17.3x, and 14.7x in 2010.

Given the market rise of late has not been supported by strong operating earnings, we cut our market rating to neutral, particularly given the 6 percent upside to our 12-month bottom-up index target of 2,450.

We believe a sizeable correction is in order, particularly given the prospect of unexciting earnings in Q3.

Given the bottom line distortion resulting from foreign exchange gains - the currency moved from Rp 11,700 at the end of March 2009 to Rp 10,268 per US dollar at the end of June - we focus on sectors that have managed to book double-digit accelerating operating profit year-on-year growth to classify what should fall in the "good" category.

In this regard, the cement sector has performed well since Q4 of 2008, thanks to price increases and lower energy-related costs that account for some 40 percent of Cost of Goods Solds (COGS).

This is followed by the property sector on the strength of PT Bakrieland Development, and the construction sector on the back of PT Wijaya Karya's strong performance.

In subsequent quarters, we expect these interest-sensitive counters (cement, property and construction) to continue to perform well on continued low rates.

If we exclude PT Astra International due to its large exposure to commodities, the consumer sector booked a double-digit operating profit growth, although at the bottom line, we noticed some deceleration.

It is worth-noting the banking sector is off the "good" list for the first time since Q3 of 2008.

The bad sectors are those that reported deceleration in terms of year-on-year operating growth in Q2 compared to Q1.

The banking and coal sectors are new joiners to this group, having been on the "good" list in the past quarters. They are joined by the telco sector, which graduated from the "ugly" sector last quarter, helped by the low base that occurred in Q2 2008. Additionally, it is worth noting that PT Telkom's Q2 net earnings have been hugely supported by foreign exchange gains.

In Q3, we expect these three sectors to remain in this category.

For banks, we foresee Q3 earnings growth will generally worsen (with a year-on-year growth at a slower pace compared to the previous quarter), if not at par with Q2 performance.

Further contraction in net interest margin (NIM) is anticipated while loan growth might be fully contributed in Q4 and beyond.

At the same time, recovery in asset quality tends to be slow but the bottom of worsening non performing loans (NPLs) is believed to be over.

Overall, we believe the outlook for the banking sector remains attractive as the interest rate is expected to hover low, and loan growth starts to excel in the subsequent quarters. Moreover, the recovery in NPLs continues.

This final category belongs to the sectors that booked negative year-on-year growth in their Q2's operating and net earnings.

In the oil & gas sector, PT Medco Energi has reported a deterioration in earnings since the last quarter of 2008, caused by the high base in oil prices. With oil prices having peaked in July 2008, we expect this sector only to begin seeing year-on-year improvement in their Q4 earnings.

In the plantation and mining sectors, due to low CPO and metal prices, both have remained in this category since Q2 of 2008, and we believe they will remain there through the Q3 results, which will only be released end of October.