Morgan Stanley remains constructive on Indian equities, saying the market could be entering a multi-quarter growth upcycle as investment, earnings and domestic demand gain momentum.
In its latest India Equity Strategy Playbook, titled “A Long Way Up”, the brokerage said supportive valuations could help equity market performance improve considerably in the months ahead. It identified the widening growth gap between India and the rest of the world as the key trigger for markets.
Morgan Stanley expects India's investment-to-GDP ratio to rise to 37.5% over the next five years, pointing to improving investment as one of the key pillars of the growth cycle. Monetary policy support, an undervalued rupee, limited fiscal headwinds and improving consumer sentiment are also expected to support the recovery.
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The brokerage also sees India's earnings cycle strengthening. It said broad-based growth acceleration, robust domestic flows and a growing IPO pipeline could support equities, while foreign investor positioning remains weak and relative valuations are close to multi-year lows.
According to Morgan Stanley, India's share of global profits is now above its weight in global equity indices by the widest margin outside 2009. The brokerage believes this combination of earnings strength and subdued foreign positioning could provide further room for Indian equities to recover.
Morgan Stanley argues that the recent de-rating in Indian equities is more likely to be cyclical than structural. Concerns around slowing population growth and artificial intelligence hurting India's large services sector, in its view, are overstated.
While AI could pose a near-term risk to India's services exports, the brokerage believes it could eventually raise labour productivity. It also sees opportunities for India from a more multi-polar global economy, a widening consumer base and stronger investment.
The valuation argument also remains supportive. Morgan Stanley's data show the MSCI India trailing price-to-book ratio at 3.3, with its analysis implying a 10-year annualised return of 11.3% at that valuation level.
The brokerage prefers domestic cyclicals over defensive and externally facing sectors. Its portfolio is overweight Financials, Consumer Discretionary and Industrials, while it is underweight Energy, Materials, Utilities and Healthcare.
Within these sectors, Morgan Stanley has raised its exposure to Consumer Discretionary and Industrials by 300 basis points each, while Financials carry a 200-basis-point overweight.
It expects consumption to benefit from lower interest rates, lower taxes and improving incomes. A pickup in private capital expenditure is the key reason behind its bullish stance on Industrials, with energy, mining, defence, fertilisers, semiconductors and data centres seen as potential new capex drivers.
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For banks, Morgan Stanley expects net interest margins to bottom out, while strong credit growth and benign credit costs could support the next earnings cycle.
Interestingly, IT services remain a potential dark horse. Although the sector faces risks from weaker US growth and the AI debate, Morgan Stanley believes Indian IT companies could benefit over the medium term as global businesses increasingly turn to them to build AI applications and solutions.
The brokerage cautioned that the biggest risks to its outlook are external, including geopolitical tensions and a slowdown in global growth. Domestically, weak farm productivity, judicial capacity constraints and the potential impact of AI on labour markets remain concerns.
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