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“India appears to be in a structural uptrend with a likely new profit cycle, supportive policy, likely rise in fixed income flows, new issuances and falling return correlations with the world,” he said.

“We expect earnings to compound 27 per cent annually over the next couple of years and the Sensex to rise 16 per cent in our base case to 70,000 (Dec 22) – albeit mostly in the back half of 2022. Our FY22 earnings estimate has been lowered by 7 per cent, but FY23 numbers are unchanged. Index returns are likely to trail earnings growth as the market digests trailing returns,” Desai added.

In bull case, Morgan Stanley believes Sensex could hit 80,000 in 2022, but for that some things need to come along India’s way – India gets included in the global bond indices resulting in near $20 billion inflows, there is no COVID wave 3 or any associated lockdowns, dollar and oil prices are range bound and RBI’s exit is delayed.

Desai, in the note co-authored with two others, accepted that the current headline valuations look rich, but argued that they must be seen in the context of depressed long-term earnings. Thanks to the humongous rally, Nifty50’s price-to-earnings multiple has reached all-time high levels of 26 while price-to-book stood on the cusp of kissing 5 level.

Indian equities are running into many challenges, including the US rate cycle, rising oil prices, elections in key states, potential Covid wave 3, upward inflexion in domestic interest rates, rich headline valuations and strong relative trailing performance, noted the analysts.

In the run-up to the all-time high till now, the volatility indicator has largely been subdued, but that may become a thing of the past, said analysts. They added that the risk to the market is also increasing, which will keep traders on their toes. Interestingly, Morgan Stanley had recently downgraded India to equal-weight.

“The index has been remarkably devoid of volatility over the past several months with both implied and realized vols low relative to history. With higher valuations and more event risks on the horizon, volatility is slated to rise, especially in the broad market,” said Desai.

Morgan Stanley’s strategy going forward is to focus on stock picking rather than macro investing, sticking with cyclicals rather than investing in defensive and choosing largecaps over smallcaps.

“Our key macro themes include a strong pick up in consumption, normalization of RBI policy and rising share of manufacturing share in GDP. We are backing financials, cyclical consumption and industrials and are relatively cautious on export sectors,” said Desai.

According to him, the key theme for the upcoming calendar year will be clean energy spend, defence indigenisation, a new residential property, auto and air travel cycle, multiyear credit cycle for financials, life insurance, digital transformation, hyper-local commerce and market share concentration plus horizontal growth for discretionary and staple consumption and electric vehicles.