Return prospects in Indian markets improving for second half

US investment bank and financial services company Morgan Stanley estimates that leading indicators are tilted to upside risk in index returns in Indian equities, improving the return outlook for the second half of 2021.

Morgan Stanley said the Indian market’s ongoing consolidation is improving its return prospects going into 2H21 albeit the immediate triggers pertain to the pace of the likely deceleration of the second Covid-19 wave and improvement in vaccine supply.

“Our leading indicators relating to fundamentals, both macro (including growth, stability,government policy and RBI policy) and corporate earnings, are generally positive about equity returns. Cross-asset and sentiment indicators are neutral on equities,” Morgan Stanley said.

The challenge for stocks comes from waning liquidity and valuation support. With accelerating earnings and reasonable relative valuations, trailing underperformance and strong policy traction, India seems set to beat EM, it added.

Morgan Stanley said this is a stock-picker’s market, with ample alpha opportunity underscored by falling correlation of returns across stocks. The pecking order: Domestic cyclicals, rate sensitives, global cyclicals, defensives exporters and mid-caps over large caps over small caps.

The second wave of the pandemic may have peaked in India and the market is now looking at how quickly the wave descends, in addition to how much the vaccination drive can be ramped up. The change in growth rate has turned negative in most states, and hospital loads and incremental case fatality rates are also declining.

“The loss of human life has been enormous, but the second wave is likely to have a lower economic impact given the lower stringency of lockdowns compared to last year,” the report said.

That said, stringency is up from the end of March, which implies a QoQ growth deceleration in the F1Q22 numbers. The equity market is likely to look through this since it has learnt that most of such demand destruction is temporary.

“India’s average daily vaccinations at 2.1mn doses/day is down 40% from its April peak – a significant concern for the stock market,” Morgan Stanley said.

India faces two opposing challenges — immediate shortages of vaccine supply and a medium-term problem of convincing people to get vaccinated. At the margin, the equity market will be assessing the shift in vaccine supply as a key input.