Morgan Stanley sees three major reasons for an 18% rise in Indian stocks this year: economy, earnings, and retail investors

After nine consecutive years of growth, can the Indian bull market continue? Morgan Stanley is optimistic, predicting that India will become one of the best-performing emerging markets by 2025.

In a recent report, Morgan Stanley analysts, including Ridham Desai, expect that the BSE Sensex index has an 18% upside potential by December 2025. The investment bank believes that India's fundamentals are primarily supported by three factors:

Macroeconomic stability: Benefiting from improved trade conditions and a flexible inflation targeting system.

Strong earnings growth: Expected to grow 18-20% annually over the next 4 to 5 years, mainly driven by an emerging private capital expenditure cycle, corporate balance sheet re-leveraging, and structural growth in discretionary consumption.

Reliable domestic sources of risk capital: These factors have reduced India's beta coefficient relative to emerging markets to about 0.4, explaining its higher price-to-earnings ratio.

In 2024, the Nifty 50 index and Sensex index are expected to rise by 8.8% and 8.2%, respectively, marking the ninth consecutive year of growth, mainly supported by domestic institutional investors and the continuity of policies after the ruling party's re-election in India.

Five Catalysts for the Indian Stock Market

Morgan Stanley believes that five catalysts will help further boost the Indian stock market.

First is a new round of reforms. The results of the Maharashtra state elections have alleviated market concerns about the central government's ability to implement reforms. Policy focuses include reducing the fiscal deficit to zero, increasing infrastructure spending, restructuring goods and services tax rates, direct tax reforms, signing more free trade agreements, and focusing on energy transition.

Second is earnings expectations. Morgan Stanley's estimates are higher than market consensus, predicting that the earnings of Sensex index constituents will compound annually by 17.3% before the fiscal year 2027, which is 15% higher than market consensus. Morgan Stanley's proprietary earnings growth leading indicators suggest a moderate earnings outlook.

Third is global market growth. Morgan Stanley believes that although the correlation between the Indian stock market and global markets continues to decline, absolute returns are still linked to the global economy, and policy actions in China and the United States, as well as global conflicts, may affect Indian corporate earnings and stock market performance.

Fourth is interest rate cut expectations. Morgan Stanley expects the Reserve Bank of India to begin a moderate easing cycle in February 2025, with a total rate cut of 50 basis points, implemented in two 25 basis point cuts. The Reserve Bank of India is committed to maintaining persistent liquidity, and regulatory measures may be relaxed in the coming weeks.

Fifth is strong retail demand. Morgan Stanley states that while new stock issuances in India are increasing, retail demand remains high. Currently, the scale of new stock issuances is about 1.3% of GDP, down from a previous peak of 3.5%, but is expected to increase further In summary, Morgan Stanley expects the BSE Sensex index to have an 18% upside by December 2025. However, Morgan Stanley believes that the Indian stock market may become a stock-picking market in the future, rather than one driven by top-down macro factors, contrasting with the situation since the COVID-19 pandemic.

In terms of investment strategy recommendations, Morgan Stanley believes that cyclical sectors are superior to defensive sectors, small and mid-cap stocks are superior to large-cap stocks, and recommends overweighting financials, consumer discretionary, industrials, and technology sectors, while underweighting other sectors.