Morgan Stanley downgrades India equities on high valuation, follows Nomura, UBS; stays structurally positive

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October 29, 2021 2:08 PM

India share market bulls may take a breather for the next three to six months as expensive valuations limit returns on Dalal Street.

Nifty, SensexRecently, domestic markets have been under pressure after hitting all-time highs as inflation concerns and expensive valuations take center stage. (Image:REUTERS)

India share market bulls may take a breather for the next three to six months as expensive valuations limit returns on Dalal Street, according to Morgan Stanley. Global brokerage firm Morgan Stanley has downgraded India equities to equal-weight in its recent Asia Emerging Market strategy note, after similar downgrades by Nomura and UBS recently. “We take profits on our India OW, but remain structurally positive…,” Morgan Stanely said.

Recently, domestic markets have been under pressure after hitting all-time highs as inflation concerns and expensive valuations take center stage. Last week, UBS downgraded India terming the market as “extremely expensive”. Along with UBS, Nomura too downgraded India from ‘overweight’ to ‘neutral’ citing expensive equity valuations.

Expensive valuations to limit returns

“While the fundamental leading indicators are positive, we see valuations as increasingly constraining returns over the next 3-6 months, particularly as we head towards Fed tapering, absorbing the impact of higher energy costs and our expectations of a first RBI hike for the cycle in February 2022,” Morgan Stanley said. They added that after the already-sharply upgraded consensus earnings through 2021, India’s 12-month forward P/E ratio has moved to an all-time high of 24.1x, making Dalal Street the most expensive market in their model on EM-relative 5-year trailing z-score of P/B and P/E.

So far this year, Sensex and Nifty have zoomed 25% and 27%, respectively. However, since the middle of October both the headline indices have slipped more than 3% each. Meanwhile the volatility gauge has zoomed 9%.

Structurally positive on India

Although India has been downgraded, analysts at Morgan Stanley added that the country is otherwise on a multi-year earnings recovery and current headwinds may only be short-term. They highlighted that MSCI India has generated 26% in the last 6 months and has outpaced MSCI EM index by 30% over the same period. This strong outperformance is partly due to bullish consensus earnings expectations and a favorable reform agenda.

Earlier this year, Morgan Stanley’s India Equity Strategy team, led by Ridham Desai has said that nascent signs of capex, supportive government policy for higher corporate profit share in GDP and a robust global growth outlook will help India enter a new profit cycle, which may result in earnings compounding at over 20% per annum for the next 3-4 years. Currently the brokerage firm prefers consumer discretionary and financials while avoiding technology and healthcare sector in India.

What UBS, Nomura had said

Earlier last week, analysts at UBS had said that India, aligned with Taiwan and Australia were the least favored markets for them. They added that India has expensive valuations with fading earnings momentum while scope for economic rebound this year reduces. Meanwhile, analyst at Nomura said that they now see an unfavorable risk-reward given valuations, as a number of positives appear to be priced in, whilst headwinds are emerging.

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