Is 18-Month Time Correction in India Over? Morgan Stanley Answers

Morgan Stanley said India's absolute returns have stagnated since October 2021 and relative returns have fallen since the end of October 2022. However, a positive case seems to be building even as this remains a stock pickers' market, it added.

India has given up most of its 2022 relative performance, Morgan Stanley said in an investor note, adding that it remains underweight on India in an emerging market (EM) context, given its view on improving conditions for some large EMs such as China, South Korea and Taiwan.

“While relative valuations remain rich and India’s low beta status implies it underperforms an EM bull market, India 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.

Key highlights from Morgan Stanley’s India Equity Strategy Playbook:

TIME CORRECTION

• Rising short-term interest rates, rich absolute valuations, worsening global liquidity and offsetting institutional flows have probably capped stock indices.

• With each of these now showing signs of turning, it is quite possible that the 18-month time correction could end in the coming weeks.

STOCK PICKERS’ MARKET

• India is still a stock pickers’ market – approach with a barbell portfolio.

• Stock picking > macro investing, Cyclicals > Defensives, Small & Mid Cap > Large-caps.

• Overweight on financials, technology, consumer discretionary and industrials, while Underweight on all other sectors.

INDEX TARGET

• The BSE Sensex target of 68,500 implies upside potential of 15% 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.

• The premium over the historical average reflects greater confidence in medium-term growth.

The BSE Sensex slipped 0.3% to 60,060.09 in early Mumbai trading today.

SECTOR VIEWS

Financials

• Peaking short rates, higher credit growth, and peaking credit costs imply outperformance for financials, especially for the non-bank lenders.

Technology

• Position reflects the barbell strategy. Least exposed to domestic growth although US recession is a risk.

Consumer Discretionary

• A recovery in rural demand is likely to aid overall consumption demand. Key upside risk is falling raw material costs and downside risk is slower urban growth.

Industrials

• Strong government capital expenditure and a nascent pickup in private capex drives Overweight stance.

Communication Services

• Pricing power could improve, but better opportunities are available elsewhere.

Utilities

• Underweight given the sector’s lack of cyclicality.

Consumer Staples

• Fundamentals could improve as raw material prices recede and rural growth recovers. However, stocks remain richly valued and in its barbell strategy, the brokerage prefers cyclical consumption.

Energy

• Prefers domestic cyclicals over global cyclicals.

Healthcare

• Avoiding defensive sectors.

Materials

• Prefers domestic materials over global ones. In addition, takes cyclical exposure via industrials.

FOCUS LIST

Following are the key stocks from Morgan Stanley’s focus list:

KEY RISKS

• A US recession could dampen the sentiment.

• A rise in commodity prices due to China’s growth recovery could delay an exit for the Reserve Bank of India (RBI) as inflation rises and the balance-of-payment remains an imponderable with consequences on domestic liquidity.

• Stocks are not outright cheap as the market continues to price in mid-teen earnings growth, although the brokerage’s top-down estimate is 10% of the consensus.

• The most important catalyst in the second half of 2023 is the market’s view on the 2024 general election outcome.

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