“India’s macro stability remains in its best shape in several years and policy momentum is the best since 2007. Financial conditions look easy and the inflation trajectory suggests more rate cuts are in the pipeline.. We think there is a case for a big asset allocation shift for domestic investors to equities – the last time an equivalent valuation opportunity in favor of equities arose was in June 2013,” said Morgan Stanley analysts Ridham Desai and Sheela Rathi in a new report.
“Superior growth prospects, a shift in funding mix to FDI, better terms of trade, reforms, and a domestic liquidity supercycle for stocks are driving India’s P/E (stock valuation) premium,” they added.
They pointed out that India has delivered poor stock market returns in the last two years, but this will change in 2017.
“Equities (are) likely to deliver 15% INR returns in 2017 compared to -3% in 2015 and 2016. Equity valuations relative to bonds are best since the global financial crisis,” the duo said.
“The low return environment that India seems to be trapped in may get a breather in 2017 thanks to better equity valuations, the bottoming of the growth cycle (disrupted temporarily by the recent demonetization) and higher correlations with world equities on which we are more constructive. If history is a guide, the trailing EPS growth sets up Indian stocks for strong medium term (5-year) performance,” Morgan Stanley said.
It said that there could still be some more downside to stock valuations, but the medium term prospects are intact.
“Our proprietary sentiment indicator has still not hit the buy zone so there may be some downside in the near term and thus, the recovery from the recent damage to share prices may not be V-shaped.
Morgan Stanley said it is investing in interest-rate sensitive sectors like Consumer Discretionary, Financials, Technology, while being underweight on Staples, Energy, Industrials, Telecoms and Utilities.