Global investment bank Morgan Stanley forecasts that the recent de-rating observed in India's largecap stocks is cyclical rather than a long-term secular trend. The firm anticipates a significant earnings cycle unfolding in the coming quarters, potentially pushing India's profit-to-GDP ratio to new highs.
According to Morgan Stanley's India Equity Strategy Playbook note, both macro and micro fundamentals in the country are robust, providing a solid foundation for largecap stocks in the months ahead. A key catalyst for this shift is the market's perception of the growth gap between India and the global economy, which is expected to narrow as global sentiment becomes more cautious on AI capital expenditure and India's growth accelerates.
Cyclical Downturn, Not Secular Shift
Morgan Stanley attributes the recent largecap de-rating, which pushed these stocks into bear territory, to a sharp negative gap in relative growth. While India's growth appears to have bottomed out and is now trending upwards, it still trails growth seen in other economies, especially those closely tied to the AI capex cycle. The bank dismisses secular arguments for a prolonged downturn, such as falling fertility rates or AI's impact on India's services economy, stating these concerns are exaggerated.
"For equity investors, the mix is compelling: broad-based growth, robust domestic equity flows, a nascent IPO pipeline, the weak trailing 12-month relative performance, relative valuations just off all-time lows and foreign positioning that remains very weak," Morgan Stanley stated.
The firm argues that a slowing fertility rate, being gradual, could actually support growth over the next two decades, even if it eventually diminishes India's long-term demographic advantage. Similarly, while AI poses a near-term risk to India's services export momentum, it also presents an opportunity to boost labor productivity from a low base in the medium term. Longer-term growth is further bolstered by a multipolar world expanding India's share of global goods trade, an expanding consumer base, and a notable increase in investment.
Favored Sectors and Key Risks
Morgan Stanley favors domestic cyclicals over defensive and externally facing sectors. The bank is overweight on:
- Financials
- Consumer Discretionary
- Industrials
Conversely, it is underweight on Energy, Materials, Utilities, and Healthcare. Interestingly, IT Services are identified as a potential "dark horse," as global demand for building AI applications and solutions is expected to drive business towards these firms.
Despite the optimistic outlook, Morgan Stanley highlights several potential risks:
- A bunching up of new market issues.
- Early tightening of monetary policy to address supply-side inflation pressures.
- Sustained oil prices exceeding $120 a barrel.
- A significant global geopolitical or economic incident.
Longer-term concerns for the firm include weak farm productivity, capacity bottlenecks within the judiciary, and the potential impact of embodied AI on labor markets.