Morgan Stanley Goes Overweight on Financials

Global investment house, Morgan Stanley, has raised its weight on Indian financial stocks. In its latest report, Morgan Stanley has gone 600 bps overweight on Financials while it is now 500 basis points underweight on IT sector. Morgan Stanley is also underweight on other sectors like healthcare and in materials. But, why exactly have they have gone overweight on financials at this juncture?

At the current point of time, there are several headwinds for the financial sector. For example, the US Fed is expected to hike the Fed rates by 75-100 bps in the current year after the taper is completed in March. It is apprehended that RBI may also follow suit. Rising rate are not good news for banks and financials because it raises the cost of funds on the one hand and elevates the risk of investment portfolio losses on the other.

The other headwind is at the asset quality level. While the Omicron has not been as serious as COVID-19, it has still curtailed the free flow of economic activity. If the situation gets grimmer then the restrictions may tighten and if corporates get into a liquidity crunch then the debt servicing ability may be impacted. Such a situation could easily lead to higher non-performing assets and impact the asset quality of financials, especially consumer portfolio.

Despite these headwinds, Morgan Stanley has given 3 specific reasons for going overweight on financials. Firstly, it expects the credit costs to have peaked and from this point the costs would either be stable or trend lower. Secondly, they are expecting credit growth to improve and the demand was most likely to be driven by the consumer and the corporate borrowing space. Lastly, let us look at the mean reversion theory in detail.

Morgan Stanley also is of the view that these financials have a lot of catching up to do. In the last one year, financials have grossly underperformed the Nifty in general and specific sectors like metals, materials and even IT. That is the reason, Morgan is expecting a mean reversion in the current year wherein the financials and cyclicals would outperform the IT sector, pharma sector and the materials space.

Morgan Stanley has pencilled a compounded annual growth rate (CAGR) of 20-30% in the earnings of large banks over the next three years, which should make current valuations look extremely attractive for the front line banks. In terms of specific stocks, they are positive on Axis Bank, SBI and ICICI Bank.