Morgan Stanley downgraded Indian equities to equal-weight from overweight on Thursday due to expensive valuations, and said it expects the market to consolidate ahead of potential "short-term headwinds".
The brokerage said while the country's key fundamentals are positive, at 24 times forward price-to-earnings, Indian equities could see some consolidation ahead of the Fed tapering, a likely rate hike by India's central bank in February, and higher energy costs.
Morgan Stanley's downgrade follows similar moves by Nomura and UBS over expensive valuations. Indian stocks have strongly outperformed other emerging markets this year, with the MSCI India index up 27.53%, compared to a 0.65% slip in the MSCI Emerging Market index.
Morgan Stanley attributed the outperformance to bullish consensus earnings expectations and a "favourable" government reform agenda.
The brokerage had said in an earlier report that nascent signs of capital expenditure, supportive government policy and a robust global growth outlook may result in India earnings compounding at over 20% per year for the next three-four years.
"While the fundamental leading indicators are positive, we see valuations as increasingly constraining returns over the next 3-6 months," Morgan Stanley said.
The blue-chip NSE Nifty 50 index has surged nearly 28% this year, crossing the 18,000-mark for the first time ever. The index fell 1.67% on Thursday and was down more than 3.7% from its all-time high.