Mumbai (Maharashtra) [India], November 18 (ANI): The domestic stock markets are expected to recover strongly in 2026 after delivering their weakest performance recently in the last three decades, according to a report by Morgan Stanley.

The global financial firm noted that following their 'worst underperformance in three decades', Indian stocks are poised to 'regain their mojo' over the next 12 months.

The report said policy has shifted in a supportive direction and is likely to drive a strong revival in nominal growth. This, in turn, is expected to pull earnings growth out of the mid-cycle slowdown seen in the past year.

Morgan Stanley added that relative valuations have corrected and are now in line with expectations of improved forward performance.

At the same time, foreign portfolio investor exposure to India remains 'the lightest in history,' while the structural domestic bid continues to remain strong.

The firm said India's long-term story has been reinforced by a series of reforms, placing the market in a strong position to reverse 'its worst performance relative to EM in 31 calendar years.'

Morgan Stanley forecasts a 13 per cent upside in the BSE Sensex through December 2026 in its base-case scenario.

This outlook assumes the continuation of India's progress in macro stability, led by fiscal consolidation and increased private investment. It also factors in robust domestic growth, steady global growth and benign oil prices.

The report further said it anticipates a resolution to the tariff-related issues between India and the US in the coming weeks.

For monetary policy, the base case includes another 25 basis point reduction in short-term interest rates and a positive liquidity environment.

The firm added that it does not expect bunching of issuances and sees the retail bid staying ahead of supply. Sensex earnings are projected to grow at a 17 per cent CAGR through F2028.

According to the report, India is ending 2025 with its worst relative performance versus emerging markets since 1994. Relative valuations have corrected meaningfully and may have bottomed out in October.

The brokerage expects a positive growth surprise ahead, supported by reflation efforts by the RBI and the government, including rate cuts, a CRR cut, bank deregulation and liquidity infusion. Front-loaded capex and nearly Rs1.5 trillion in GST rate cuts, mainly directed at mass consumption, are also expected to aid the recovery.

The report added that thawing relations with China, China's anti-involution drive, and a likely India-US trade deal should further lift sentiment. It said India's previously hawkish post-COVID macro stance is now unwinding.

'Anti-involution' is a recent economic policy in China aimed at curbing excessive competition and overcapacity.

Morgan Stanley identified the growth slowdown that began in the second half of 2024 and elevated relative valuations as the main reasons for India's recent market underperformance.

The absence of explicit AI-related trades, delays in the US trade deal, and India's low beta in a global equity bull market have also contributed to volatility. (ANI)