Will largecap de-rating prove cyclical? Morgan Stanley identifies what may lift share prices

Morgan Stanley, in its India Equity Strategy Playbook note, said macro and micro fundamentals are in good shape and should support largecap stocks in the months ahead. The principal catalyst, it said, is how the market gauges the growth gap between India and the world. This is seen shifting when global sentiment turns cautious on AI capex and India’s growth accelerates.

The global investment bank said the recent de-rating, which pushed largecaps into bear territory, appeared cyclical. It said the de-rating itself was the outcome of a sharp negative gap in relative growth, with India’s growth appearing to have bottomed and now trending higher, yet still trailing growth seen elsewhere, particularly in economies tied to the AI capex cycle.

Calling India a defensive growth market, Morgan Stanley said it sees a major earnings cycle unfolding over the coming quarters that could take profit-to GDP to new highs.

"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 said.

The foreign brokerage favoured domestic cyclicals over defensives and externally facing sectors. It is overweight Financials, Consumer Discretionary and Industrials; underweight Energy, Materials, Utilities and Healthcare. Morgan Stanley said IT Services may prove the dark horse as the world turns to these firms to build Al applications and solutions.

The global investment cited risks such as bunching up of new issues, early tightening to address supply-side inflation pressures, oil prices in excess of $120 a barrel for long and a global incident.

Longer term, Morgan Stanley said, it is concerned about weak farm productivity, capacity bottlenecks in the judiciary and embodied Al weighing on labour markets.

On whether the recent largecap derating is secular or cyclical, Morgan Stanley said the secular argument rests on a projected lower terminal growth rate, driven by falling fertility rate or by Al's effect on India's sizeable services economy and trade. It sad both concerns are exaggerated.

"Slowing fertility - hardly abrupt - actually aids growth over the next two decades, even as it narrows India's very long-term demographic edge. Al poses a near-term risk to India's services-export momentum, but, over the medium term, offers a chance to lift labour productivity from a low base. Longer-term growth is further underpinned by a multi-polar world that   can expand India's share of global goods trade, a widening consumer base and a marked pickup in investment," Morgan Stanley said.

It therefore sees de-rating as cyclical.