India market faces rocky ascent

The Sensex will grow 14% but there are gaping risks for stock pickers, says Morgan Stanley.

Even large-cap conglomerates will not be sure bets, and investors are advised to steer clear of whole sectors like the materials industry.

Here's more from Morgan Stanley:

Focus on Stock Picking over Sector Themes
We expect the market to make upward progress marked by volatility. We see a 14% upside to the Sensex in 2012 with rising likelihood for better returns. We think investors are best placed to choose stocks rather than pursue sector themes. We prefer mid-cap over large-cap names.

Key Factors to Watch
Inflation data is already moderating, setting the stage for monetary easing. The bad news on policy has stopped, although the volatility emanating from a weak developed world could keep pegging back Indian equities.

Where We Differ
Going into 2012, earnings have support from low gross margins, low operating leverage and peaking capital costs. The F2013 consensus estimates bear upside risks. Long bond yields may have topped out. Valuations are attractive on an absolute basis and, market positioning, as evidenced by our proprietary sentiment indicator, is still bearish. Together with the collapse in earnings revisions, this sets up the market for an upward move in 2012, in our view.

Risks to Our Call
During the 2008 crisis, Indian earnings outperformed, but equities fell due to a large outflow of capital. Significant global stimulus or a breakdown in capital markets would hurt India, a la 2008.

Portfolio Strategy
Our sector calls remain narrow given our view that this is a stock pickers’ market. We reiterate our preference for domestic over global cyclicals. Consumer Discretionary is our favored rate-sensitive sector. Top sectors to avoid remain Materials and SOE Banks. Our top picks from our Focus list include INFO, MM, DRRD, ICIC, ZEE and Coal. See page 22 for our mid- and large cap picks, as well as our sector positions.