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A man walks past the BSE building in Mumbai
A man walks past the BSE building in Mumbai

Morgan Stanley's Ridham Desai says Indian markets remain 'attractive', likes mid-caps

  • Morgan Stanley prefer cyclicals over defensives.
  • The themes we like include agriculture, manufacturing and early cycle rate plays, say Ridham Desai and Sheela Rathi

India’s stock market continues to remain attractive despite its outperformance over other emerging markets the past six months, says Morgan Stanley. But for this this outperformance to be sustained, "India needs to continue to deliver policy that lifts India’s potential growth in the eyes of market participants", say Ridham Desai, equity strategist, and Sheela Rathi, equity analyst, in a recent report.

Morgan Stanley analysts reckon that factors, including a differentiated policy response, strong corporate action through the pandemic and an attractive starting point of relative valuations, have helped India’s markets outperformance as compared to other emerging markets.

But in the short-term, Indian markets performance remains hinged to global factors, they say.

"We expect heightened volatility as the market deals with fuller valuations and extended sentiment indicators. We remain buyers of any correction that stocks may offer, as valuations are attractive relative to macro aggregates, such M2 and market cap, liquidity is strong, earnings expectations remain subdued, and policy is gaining traction with concomitant positive effects on the growth cycle," they say

Morgan Stanley noted that policy environment is improving in India, partly explaining Indian markets outperformance to other emerging markets.

"India has started to outperform EM more persistently and consistently after reaching a relative floor in March. A evolving policy response, a robust corporate sector reaction to the pandemic, and supportive valuations may explain this," they say.

"We are seeing some differentiated policy action, starting with the large corporate tax cut and more recently changes to agricultural marketing, labor law changes, incentives for manufacturing, and the proposed privatization of railways. Meanwhile, the COVID-19 situation appears to be ebbing at the margin. A bounty crop, likely recovery in exports following global growth trends and strong monetary aggregates are skewing growth risks to the upside."

Portfolio strategy:

Morgan Stanley prefer cyclicals over defensives. "The themes we like include agriculture, manufacturing and early cycle rate plays," say Ridham Desai and Sheela Rathi.

"We are in a stock picker’s market, and thus we recommend narrowing sector positions. We believe that the broad market will likely outperform, consistent with our theme that this is a stock pickers’ market," they say.

Ridham Desai and Sheela Rathi say that the broader market in India looks very attractive vs the narrow market (Nifty and BSE Sensex) and, hence, "we like mid-caps."

"We like a barbell portfolio with a mix of quality at a reasonable prices and cyclicals."

Morgan Stanley is overweight on consumer discretionary, industrials and energy, and underweight technology and consumer staples.

"We are neutral financials, but a lot of bad news is now in the price."

In the report, Ridham Desai and Sheela Rathi also note that Indian companies have used the pandemic dislocations to prepare for the next growth cycle by cutting costs (earnings coming ahead of expectations), raising capital to either boost growth or mitigate tail risks and undertaking mergers, acquisitions, and restructuring by selling part of the business to help the residual business.

"The positive effects should become visible once economic activity normalizes," they said.

"While domestic equity flows have slowed, system liquidity remains strong. India also has impending index MSCI re-balance-related flows in the pipeline. That said, stocks are likely to be volatile, with this volatility sourced from abroad," they say.

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