Indian Equity Market Remains Attractive Despite Rich Valuations, Morgan Stanley Says

The Indian equity market continues to be attractive despite rich relative valuations largely due to strong earnings growth prospects, as well as a swelling bid from both domestic and foreign investors, according to Morgan Stanley.

India, the world's fifth-largest economy, has experienced many changes in less than a decade, Morgan Stanley said in an investor note.

These include supply-side policy reforms such as a buildup in infrastructure, formalization of the economy via Goods and Services Tax (GST) and IndiaStack, massive change in real estate regulations, digitalization of social transfers making them leak proof, a new bankruptcy law coupled with a sharp decline in corporate balance sheet leverage, the brokerage said.

Other changes are flexible inflation targeting that has improved India’s macro stability, focus on the foreign direct investment (FDI), India's 401(k) moment, which has created a reliable domestic source of risk capital, as well as government support for corporate profits and multi-year highs on MNC sentiment, it added.

“Bottom line, India is rising in the world order with significant positive macro and market implications,” Morgan Stanley said.

The brokerage said the manufacturing and capital expenditure are resurgent, exports are rising, the current account is becoming more benign, consumption is undergoing radical shifts and interest rate cycles are likely to become shallower.

The concomitant profit book, lower return correlation of equities with oil and US growth/Fed cycles and a lower beta to emerging market (EM) set India up for strong equity markets, although relative valuations remain rich, it added.

Morgan Stanley said India’s low beta status implies it underperforms an EM bull market even as the country offers much stronger relative earnings growth and is also likely to benefit from the troughing of the real rate gap with the US.

The brokerage said its BSE Sensex target of 68,500 implies upside potential of 10% to December 2023. This level suggests that the BSE Sensex will trade at a trailing P/E multiple of 20.5x, ahead of the 25-year average of 20x, and the premium over the historical average reflects greater confidence in medium-term growth, it noted.

However, key risks are slower global growth, tight global liquidity, weather vagaries and their impact on farm output, potential worsening of state fiscal position and a resurgence in commodity prices, Morgan Stanley said. The most important catalyst in the second half of 2023 is the market’s view on the 2024 general election outcome, it added.

“We have exited a stock pickers’ market – approach with a barbell portfolio,” the brokerage said.

Morgan Stanley said it is Overweight on financials, technology, consumer discretionary and industrials, while Underweight on all other sectors.

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