Morgan Stanley raises exposure to financials as slew of tailwinds surface

Financials are now the biggest overweight for Morgan Stanley followed by consumer discretionary and industrials

Morgan Stanley has increased its overweight stance on the financial sector amid the emergence of multiple tailwinds. “Rising short rates, higher credit growth, and peaking credit costs imply outperformance for Financials – we double our overweight (OW) position to 600 basis points (bps),” equity strategist led by Ridham Desai and Sheela Rathi say in a note titled ‘Back Up the Truck and Load Financials.’

“We are in the midst of a big bull market, and financials have not done well. The reason is that the RBI has stayed dovish longer than the market expected. The RBI has held on to its dovish position to facilitate higher growth, and as a consequence, financials have struggled. Financials need higher short-term yields to make more money– and so, relative to other sectors, the market has expressed its view that financials are going to lag,” they add.

“This means the stars are aligned for stronger relative performance from financials, especially banks.”

Financials are now the biggest OW for Morgan Stanley followed by consumer discretionary and industrials. Meanwhile, the brokerage has the highest 500 bps underweight (UW) vis-à-vis the MSCI India index on Technology. Energy, Healthcare and Materials are the other UWs.

Morgan Stanley expects the yield curve to flatten with long-term yields softening and shorter-end rising with the RBI expected to lift rates.

Besides, it expects healthy credit growth and margin improvement.

“Credit growth accelerates with a lag versus economic growth. Given our view of improving GDP growth and banks' improving risk appetite, we expect 12-13 per cent annual credit growth over the next two years,” say Desai and Rathi.

“Corporate balance sheets are healthier, previous bad loans have been provided for, new NPL formation has slowed, and economic activity is picking up. Ultimately, credit cost lags profit share in GDP – with the latter rising, the former is likely to fall,” they add.

Morgan Stanley expects the banking pack’s earnings growth to be higher than other Sensex stocks.

“A combination of higher short rates, lower credit costs, and acceleration in credit growth will boost the banks. We expect large banks' earnings to compound at 20-30 per cent over the next three years, compared to 24 per cent for the BSE Sensex constituents.”

The brokerage has an OW stance on Axis Bank, ICICI Bank and State Bank of India.