Markets could go up 20% from here: Morgan Stanley

Improving credit quality a positive; bullish bets include private banks, industrials

A reversal of the earnings down cycle could help markets go up significantly from the current levels, according to foreign financial services firm Morgan Stanley.

Ridham Desai, head of Indian equity research, said earnings could drive an eventual recovery in market sentiment. He believes a change in the negative earnings revision trend is likely after having reached close to the worst levels in history. He has set a target of 32,500 for the Sensex for the end of the year.

It was added the recent credit upgrades have exceeded downgrades twice over, suggesting an improvement in credit position. Rating agency Crisil recently noted in its Ratings Round-up report that mid-sized companies had shown a gain in credit quality. Mid-sized companies are those with operating revenue of Rs 100-500 crore. There were more than two upgrades for every downgrade in such firms. Mid-sized ones recorded 2.26 for the six months ending  March 2015, compared to 1.55 for small-sized firms with revenues of under Rs 100 crore; and two times for large firms with operating revenues of Rs 500 crore.

BULLISH ON MARKETS

• Believe earnings decline has bottomed out
• Companies' credit ratings are improving
• Capex revival on the anvil
• Outperformers could include industrials, private sector banks, consumer discretionary stocks
• Bearish bets include energy, materials and utilities
• Operating leverage likely to score superior returns

The report had added that “a pervasive improvement in credit quality remains elusive because the value of debt seeing downgrades is far more than those seeing upgrades”.

Morgan Stanley’s target of 32,500 would suggest an upside of nearly 23 per cent from Tuesday’s closing level of 26,481 on the Sensex. The forecast comes even as the market has corrected 3,000 points from its peak; and earnings have been lacklustre.

Morgan Stanley’s May 21 India Equity Strategy report authored by analysts Ridham Desai and Sheela Rathi noted that lower interest rates and policy reform, along with improving corporate balance sheets are a positive. The report was provided during the investment summit in Mumbai where Desai and Chetan Ahya, co-head of global economics and chief Asia economist, spoke. He believes there would be an 18 per cent growth for the broader market while, the Sensex companies would see 24 per cent earnings growth.

Ahya noted emerging markets (EM) are facing a troubled growth outlook even as the developed market (DM) economies are doing well.

Amongst emerging markets, commodity producers (such as Brazil and Russia whose economies depend on their oil exports) are unlikely to have a positive change in outlook. Other emerging markets such as China have over capacity issues, said Ahya.

“There will be another year of divergence between EM and DM,” he said.

India is likely to be a bright spot on the back of improving capex. Morgan Stanley noted that capital goods imports have grown over the past four months. Engineering and construction companies have seen an increase in order flows, and data show a revival in projects under implementation, projects revived and fresh investments.

The Centre for Monitoring Indian Economy (CMIE) noted that projects worth Rs 47,300 crore were completed in April 2015. The manufacturing sector saw 26 projects worth Rs 23,300 crore being implemented, 13 power projects worth Rs 20,700 crore were also implemented.

Additionally, transport services implemented six projects worth Rs 300 crore. There were also project completions in the construction and real estate services segment, noted CMIE.

The upside will not be without some volatility, noted the India strategy report quoted earlier.

“US Fed moves and other global factors… will continue to drive volatility in Indian equities, which we expect to be higher than in the past 12 months. Global growth, China growth, oil prices, EM news flow and US Fed moves as an indicator of global liquidity, among other things, are factors to watch,” it said. According to Morgan Stanley, industrials, private sector banks and consumer discretionary stocks will do well as the market recovers.