Indian stocks, Desai argues in a strategy report, now offer an unusual mix of “inexpensive relative valuations, poor trailing performance, strong policy stimulus and a consequent growth upcycle, an undervalued currency, weak foreign positioning and potentially a new buyback cycle.”
The 12-month trailing performance is “the worst in history” even as relative valuations are “approaching previous troughs”, with foreign portfolio investor (FPI) positioning having weakened steadily over the past four years. “India could be a pain trade, which may just accelerate the returns on stocks,” the report notes, adding that an undervalued rupee and a friendlier tax regime are likely to trigger “more buybacks” and keep net equity supply modest.
On the macro front, Morgan Stanley sees “a sharp turn in earnings growth over the coming months” as India’s growth cycle accelerates on the back of a coordinated reflation effort by the Reserve Bank of India and the government. The report cites the combination of rate cuts, bank deregulation, liquidity infusion, continued capex, tax reductions and a “relatively stimulating budget” as evidence that “India’s hawkish macro set-up post-Covid is now unwinding.”
Trade deals and a thaw in relations with China are seen as additional tailwinds to growth and risk appetite.
This macro backdrop feeds directly into the re-rating argument. Desai highlights that “the falling intensity of oil in GDP and rising share of exports in GDP, especially services, and fiscal consolidation imply a lower saving imbalance,” which in turn should allow “structurally lower real rates.” At the same time, lower inflation volatility, driven by supply-side reforms and flexible inflation targeting, should mean “volatility in interest rates and growth rates is likely falling in coming years.” Morgan Stanley’s base case sets a December 2026 Sensex target of 95,000, implying upside of 13% and a trailing P/E of 23.5 times, above the 25-year average of 22 times, to reflect “greater confidence in the medium-term growth cycle in India, India’s lower beta, a higher terminal growth rate and a predictable policy environment.” The base case rests on continued gains in macro stability through fiscal consolidation, increased private investment and a sustained positive gap between real growth and real rates, alongside “robust domestic growth, steady global growth and benign oil prices.”
The bull case, with a 30% probability, pegs the Sensex at 107,000 by December 2026, assuming oil prices “persistently below US$60 per barrel”, successful reflation that lifts growth estimates, and a curtailment of the global trade war, with Sensex earnings compounding at 19% annually over FY25–28.
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The bear case, assigned a 20% probability, takes the Sensex down to 76,000 if oil spikes above US$90 per barrel, the RBI is forced to tighten, global growth slows materially and the US slips into recession, with earnings growth moderating to 15% and equity multiples de-rating to reflect a weaker macro environment.
Underlying the optimism is a call that the earnings cycle is turning. The firm’s proprietary leading earnings indicator “is suggesting improving earnings growth”, while its composite valuation indicator, which blends 11 absolute and relative metrics, points to “equity returns of around 16% in the next 12 months.” Sensex earnings in the base case are projected to compound at 17% annually through FY28, with the top-down framework for the broader market showing EPS growth of 22% in FY26, 20% in FY27 and 17% in FY28.
Positioning and sentiment are the other key pillars of the re-rating thesis. India’s weight in global emerging market funds relative to its MSCI EM weight, and FPIs’ shareholding gap between the top 75 companies and the broader market, suggest “India could be the pain trade in 2026” if global investors are forced to add to underweight positions. Morgan Stanley’s proprietary sentiment indicator, which combines flows, volatility, trading activity and breadth, is firmly in the “buy zone”, indicating a contrarian opportunity.
Meanwhile, the real effective exchange rate is near multi-year lows, historically a supportive backdrop for equities, even if the past relationship with stocks has weakened.
The portfolio stance reflects a conviction that a macro trade is now unfolding. “Domestic cyclicals over defensives and external-facing sectors,” the report says, with an overweight stance on financials, consumer discretionary and industrials, and underweight calls on energy, materials, utilities and healthcare.
Within sectors, the strategists argue that rising credit growth and low credit costs, a recovery in urban consumption and robust government as well as private capex make a strong case for domestic cyclicals to lead, while defensives and global cyclicals lag.
Desai sums up the backdrop as one where Indian equities are backed by policy, earnings and positioning, but not yet fully priced for the improving structural story. With “high growth with low volatility” and a gradual shift in household balance sheets towards equities, Morgan Stanley sees the conditions in place for Indian stocks to “enjoy a rare combination” that, in its view, justifies a re-rating over the next couple of years.
(Disclaimer: The recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of The Economic Times.)
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