Dalal Street set to jump 14% in 2024 as it bets on a majority government, says Morgan Stanley

• The outlook is based on assumptions that foresee continuity in the government with a majority mandate, stable policy, robust domestic growth, and benign oil prices.
• The global investment bank has a bias for cyclicals over defensives and large-caps over small and mid-cap stocks.
• The risk to this thesis stems from any changes in government leading to policy reform uncertainty.
  

The outlook for India's stock market continues to be positive ahead of the new year (2024) but the journey may be volatile given that general elections are around the corner. According to Morgan Stanley, the market is likely to price in continuity and a majority government, leading to a rise in equities. Several factors contribute to this positive outlook, including strong macro stability, forecasted earnings growth, and a reliable source of domestic risk capital.

One of the key factors supporting the positive outlook is India's strong macro stability, says the global investment bank. The country has seen improvements in terms of trade, flexible inflation targeting, and stable non-portfolio foreign flows. These factors have led to a reduction in correlations and volatility of Indian stocks relative to emerging markets (EM). India's beta to EM is less than 0.4, indicating lower volatility. Additionally, India's rate spread with the US has declined, further supporting the positive outlook.

Morgan Stanley forecasts a 14% upside to the BSE Sensex by December 2024 in their base case scenario. This is based on assumptions of continuity in the government with a majority mandate, stable policy, robust domestic growth, and benign oil prices. They expect BSE Sensex earnings to compound at a rate of 21.5% annually through F2026E. However, the analysis also acknowledges the potential for volatility in 2024, which is evident in their bull-bear scenarios.

There are multiple reasons for the expected rise in volatility in 2024. These include political actions from the opposition alliance, cues from US stock and bond markets, oil price fluctuations, earnings strength, uncertain monetary policy, improvements in bond flows, and an increase in net issuances. These factors could potentially moderate the strong domestic bid that has been driving share prices in recent years.

In terms of portfolio strategy, Morgan Stanley suggests favoring cyclicals over defensives and large-caps over SMID (small and mid-cap) stocks. They recommend overweighting financials, consumer discretionary, industrials, and technology sectors, while underweighting other sectors. It is important to note that the analysis highlights the current market as a macro market rather than a stock pickers' market, with the macro trade potentially peaking in 2024.

The analysis also identifies five key drivers contributing to India's structural bull market. These include macro stability and a positive balance of payments outlook, strong relative and absolute growth, the emergence of a reliable domestic source of risk capital, social equity improvements, and a consumption boom driven by rising discretionary spending.

However, the analysis also highlights key risks to the structural story. These include potential changes in government leading to policy reform uncertainty, slower global growth impacting India's external growth and funding, geopolitical challenges and associated oil price increases, structural issues in the farm sector and skilled labor shortage, and AI-related headwinds in services exports.

Looking ahead to 2024, Morgan Stanley has identified several key catalysts that could impact the Indian stock market. These include politics, earnings performance, global market trends, short rates, rise in net issuances, and bond flows. The outcome of state elections in December 2023 and the general elections in 2024 could create volatility in the market. Strong earnings performance, softer global markets, short rate movements, and changes in net issuances and bond flows are also expected to influence market dynamics.

In the end, Morgan Stanley paints a positive picture for India's stock market in 2024, with expectations of rising equities. However, the analysis also highlights potential volatility and risks that could impact the market. Investors are advised to consider these factors and adopt a portfolio strategy that aligns with the expected market conditions.