Morgan Stanley Spots Risks To India’s Stock Market Resilience
Morgan Stanley says it now finds small caps "more attractive" than large caps.
Indian equities are facing their biggest challenge in several months as risks to growth have risen and stock prices remain elevated relative to emerging markets, according to Morgan Stanley.
Against this backdrop, the financial services provider continues with its “barbell sector strategy”, according to its May 24 report co-authored by equity strategists Ridham Desai and Nayant Parekh, equity analyst Sheela Rathi and research associate Apurva Jain. “We now think small caps look more attractive than large caps.”
A barbell strategy is a concept to invest in the two extremes of high-risk and no-risk assets while avoiding intermediate choices.
“Low correlation across stocks signals a market driven by macro warranting wider sector positions,” Morgan Stanley said. It’s overweight on financials, technology, consumer discretionary and industrials, and underweight all other sectors. It prefers small caps over large caps.
The R Factors
According to Morgan Stanley, the ‘R’ factors are in the “driver’s seat”, posing risks to India's resilience.
Russia: The conflict in Ukraine is driving crude oil, fertiliser and seed prices higher bringing risks of persistent inflation and a potential rise in India’s twin deficits and a declining balance of payments, which is bad news for stocks.
Revisions: Responding to rising growth risks, consensus has reduced two-year forward BSE Sensex earnings growth estimates by 150 basis points over the past month.
Recession: The Sensex is highly sensitive to a U.S. recession. India’s three biggest bear markets of the past 20 years coincided with a U.S. recession, although it is possible (as in the case of oil) that the relationship changes in the next recession.
Rates: Rising rates are not bad if the Reserve Bank of India keeps its nose ahead of inflation. However, when the rate cycle changes (as it has), it brings volatility at the minimum.
Resilience: Indian stocks continue to outperform emerging markets, possibly due to a shift in current account funding to FDI making the oil price increase impact linear and permitting greater flexibility in policy, with positive domestic politics reinforcing the government’s thrust on lifting corporate profits, high relative real policy rates, a new profit cycle, structural domestic bid on equities and growing positivity of multinational companies toward India—our MNC Sentiment Index is at new highs.