India continues to be the cynosure of all eyes, as far as global investment firms are concerned. The strong performance by the Indian equity markets in the past 18 months, compared to other emerging markets, along with the country’s unique dynamics, continue to keep global players glued to it for generating good returns.
Consolidation and volatility
One of the world’s leading investment/brokerage firms, Morgan Stanley, continues to remain bullish on India for the near to medium term. In its recent report, the brokerage has highlighted that, in the immediate to near term, the Indian markets are expected to consolidate amidst strong volatility.
However, the overall macros and the India growth story remain strong and they provide confidence that there is more steam left in the markets, it said.
The immediate challenges for the Indian markets, it said, are the “US rate cycle, rising oil prices, elections in key states, potential third wave of COVID, upward inflexion in domestic interest rates, rich headline valuations and strong relative trailing performance.”
This will result in market consolidation and the fact that equities are trading at higher valuations will add volatility in the broader markets.
Uptrend to continue
“We have tactically downgraded India to equal-weight in our emerging markets country portfolio,” the brokerage said. However, India continues to be in a structural uptrend with a likely new profit cycle, it added.
The supportive policy, likely rise in fixed income flows, new issuances and falling return correlations with the world provide a strong foundation to this uptrend. While headline valuations of the country look rich, they must be seen in the context of depressed long-term earnings, the brokerage said.
It expects earnings to compound 27 percent annually over the next couple of years, and the Sensex to rise 16 percent in its base case to 70,000 by December 2022.
Triggers for uptrend
New profit cycle
The confidence for a new profit cycle is emanating from the fact that “the Indian economy is likely to grow at a nominal rate of 10 percent per annum, and if the profit share in GDP hits its long-term average of 3.5 percent over the next 4-5 years, it gives an annual compound growth in earnings of 20-25 percent for the broader market”.
Furthermore, higher profits feed into real GDP growth, which gets fed back into profits, so a virtuous cycle unfolds with concomitant positive impact on share prices.
New capex projects
India has laid an ambitious capex plan in multiple areas, including infrastructure, real estate, exports, PLI schemes, energy sector, climate change, etc. Rising capex will add to the margins of corporate India.
Export growth
The world is expected to witness robust overall growth with the opening up of economies that are likely to drive India’s exports, which are critical to India’s growth and macro stability.
New offerings
The spate of new IPOs has helped the uptrend in the market and the rising net flows augur well for stocks. “If this bull market is reminiscent of that in 2003-08, as we think (given a likely fresh earnings cycle), it has more legs to it,” added the brokerage firm.
Corporate earnings
Earnings are expected to grow strongly in the second half of this financial year and in the coming two years as companies would have absorbed higher material costs in the first half, ramped up general expenses as the economy opens up while operating leverage remains weak with the rise in utilisation rates.
India’s inclusion in bond index
The brokerage is optimistic of India being included in the bond index by the third quarter of 2022. This is a major positive shift in India’s macros, which neither the bond markets nor the equity markets are pricing in.
Risks to uptrend
Interest rates: The uncertainty associated with US interest rates could be a major cause of volatility in the immediate future.
Crude oil price rise: The rise in oil prices due to supply-side issues will adversely impact India’s macros and markets.
Expensive valuations: P/E and P/B may not be giving the correct picture and valuations might appear overstated due to the depressed trailing earnings and a strong earnings outlook for the medium term.
New COVID wave: There is still a possibility of a new COVID wave, which, if actually happens, can derail the near-term growth prospects.
State elections: A setback to the ruling party in Uttar Pradesh elections can upset the policy momentum, resulting in more volatility in the markets.
Possible market levels
The brokerage expects the BSE Sensex to reach 70,000 by December 2022 in its base case scenario, which has a probability of 50 percent. For this to happen, it assumes stability in the pandemic situation and a recovery in the economy.
Such a scenario is also dependent upon the RBI undertaking a calibrated exit and Sensex earnings compounding 27 percent annually over FY2021-23.
In a bull-case scenario, which has a 30 percent likelihood, the BSE Sensex is expected to reach the 80,000 levels on the back of inclusion in bond index, which will likely lead to inflows of $20 billion. Such a scenario is also dependent upon no COVID wave, oil prices remaining rangebound, and earnings growth compounding 31 percent annually over FY2021-23.
The BSE Sensex can fall back to 50,000 in a bear-case scenario, which has a 20 percent probability, if both oil price and interest rates rise. India will miss the inclusion in bond index, if there is a new COVID wave, aggressive moves by RBI to fight inflation, adverse state election results and Sensex earnings compounding 20 percent annually over FY2021-23.
Themes for 2022
The brokerage suggests investment ideas around clean energy, defence indigenisation, real estate, auto and aviation, financials, insurance, digital transformation, hyper-local commerce and electric vehicles.
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