Morgan Stanley downgrades Indian equities because of expensive valuations

Global brokerage firm Morgan Stanley in its latest report has downgraded domestic equities from ‘overweight’ (OW) to ‘equalweight’ (EW) citing expensive valuations. MSCI India has gained 26% in the last 6 months, outpacing the MSCI Emerging Markets index by 30% over the same period. Morgan Stanley said this strong outperformance is partly due to bullish consensus earnings expectations and a favourable reform agenda.

“We move tactically EW on India equities after strong relative gains. We expect a structural multi-year earnings recovery, but at 24 times forward (P/E) we look for some consolidation ahead of Fed tapering, an RBI hike in February and higher energy costs,” Morgan Stanley equity strategist led by Daniel Blake and Jonathan Garner wrote in a note on Asia Pacific markets.

Morgan Stanley becomes the latest global brokerage to either downgrade India or recommend higher allocation to other Asian markets.

In the recent past, HSBC, UBS, Nomura and Jefferies have increased weightage to China and other Asian markets, while raising concerns over India’s expensive valuations.

Morgan Stanley added that early signs of capital expenditure, 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 three to four years.

However, the financial services firm said that valuations are increasingly constraining returns over the next three to six months.

“Notwithstanding the already-sharply upgraded consensus earnings through 2021, India’s 12-month forward P/E ratio has moved to an all-time high of 24.1 times. As a result, India is the most expensive market in our model on EM-relative 5-year trailing z-score of P/B and P/E,” stated the note.

Morgan Stanley believes the Indian markets might take a breather from here and look for some consolidation. Nevertheless, it prefers consumer discretionary and financials while avoiding the technology and healthcare sectors.