India's Relative Gains May Continue To Recede In 2023, Says Morgan Stanley

India's relative gains among emerging markets may continue to ebb in 2023 as other developing economies could benefit from a "benign" global scenario, according to Morgan Stanley.

"An up-trending profit cycle, a likely peak in short rates in 1Q2023 and ebbing global macro risks relative to 2022 make the case for absolute upside to Indian stocks," the brokerage said in its Jan.11 note.

However, its relative gains may continue to ebb as they have since November 2022, it said. "In 2023, we believe emerging markets are likely to benefit from a relatively more benign world versus 2022."

India's relative valuations show that the recent retreat in its outperformance could continue in the first half of 2023, even though absolute returns are likely to be better than in 2022, the ]brokerage said.

India's outperformance was driven by government policies, such as a rise in the domestic equity savings pool, a rise in the share of corporate profits in GDP, and a focus on foreign direct investment flows, Morgan Stanley said.

A focus on FDI flows led to higher shares of foreign direct investment in the balance of payments, enabling a less sensitive monetary policy for India as compared to the U.S.

That also reduced the equity market's sensitivity to the recession in the U.S. and oil prices, the brokerage said.

Morgan Stanley expects strong earnings growth of 10% for fiscal 2024, driven by improving capex and margins. However, a higher-than-expected slowdown in global growth is a "key" risk, according to the brokerage.

India's stock benchmark, the BSE Sensex, may clock 68,500, implying a potential upside of 14% to December 2023.

"This level suggests that the BSE Sensex will trade at a trailing price-to-earning multiple of 20.5 times, ahead of the 25-year average of 20 times," the brokerage said. "The premium over the historical average reflects greater confidence in medium-term growth."

Portfolio Strategy

Morgan Stanley maintains an 'overweight' rating on financials, technology, consumer discretionary, and industrials while remaining 'underweight' on all other sectors such as utilities, communication services, consumer staples, energy, healthcare, and materials.

The brokerage expects financial stocks to outperform, aided by rising short rates, higher credit growth, and peaking credit costs. Meanwhile, a recovery in rural demand is likely to aid overall consumption demand and bode well for consumer discretionary products.

The brokerage's overweight call on industrials is due to strong government capex and a start of a pick-up in private capex.

Morgan Stanley said it prefers domestic cyclical over global cyclicals while avoiding defensive sectors altogether.