Uttar Pradesh Polls To Third Wave: Morgan Stanley Lists Key Events For Equity Market In March Quarter

Morgan Stanley sees the quarter ending March to be “eventful, volatile”, and lists key factors that may affect equity performance during the period.

“The backdrop for the quarter is that India has significantly outperformed emerging market in 2021 and that given multiple events, price volatility is likely rising from low levels,” the research house said in a Jan. 2 note—co-authored by Equity Strategists Ridham Desai and Nayant Parekh, and Equity Analyst Sheela Rathi.

Here are the key events that may shape up the first three months of 2022:

‘Constrained Earnings Season'

Morgan Stanley expects profit margin in the first half of the year to be “constrained”.

Companies will be absorbing higher material costs and general expenses should ramp up as the economy opens up, it said. “We are a tad behind consensus for the first half of 2022 even as we expect a stronger medium-term trend in earnings than consensus.”

The Budget And India's Inclusion In Global Bond Indices

The Union Budget, according to the report, rarely changes the market directionally, but it does produce volatility in stocks.

“The one potential game-changer is our expectation of a clarification on tax issues, paving the way for an inclusion in global bond indices by 3Q22.” The research house doesn't expect either the equity or bond markets pricing in this major positive shift in India's macro backdrop.

Uttar Pradesh Elections

India's most populous state is going to the polls likely in February, and the results will impact the markets, according to Morgan Stanley.

If the incumbent Bharatiya Janata Party wins with a mandate greater than or equal to its current one, the market may feel relieved. “A setback would threaten policy momentum. The government policy is a major source of our optimism. At the minimum, an adverse election result would produce volatility.”

Falling Return Correlations

India's return correlation with the rest of the world is declining, owing to likely better growth prospects. “This idiosyncratic behavior should attract overseas investors. Foreign ownership looks low historically.”

Evidence Of A Capex Cycle

India appears to have multiple sources of capital expenditure going into 2022, including energy transition, the internet, climate change, production-linked incentive schemes, growing exports, depleted capital stock, infrastructure, real estate, and foreign direct investment, the research house said.

“Rising capex is good for corporate profit margins until the capex becomes unproductive.”

New Issuances

A new bull market makes progress with high-quality new listings. Rising net flows augur well for share prices, for now, it said.

Dollar, Oil Rates

The U.S. interest rate cycle and thus the dollar could be a source of volatility in the coming months. A supply-constrained rise in oil prices would be bad for India's macro climate and markets, Morgan Stanley said.

Third Covid Wave, Omicron Effect

A potential third wave needs to be monitored and will impact the markets. India, according to the research house, is on course to vaccinate a large part of its adult population by early 2022.

Domestic Rates

The Reserve Bank of India is likely to narrow the policy rate corridor with a reverse repo hike in February, according to Morgan Stanley, which could precede a policy rate hike.