The global brokerage firm, in a research note on Friday, said: "On the absolute trailing price/book multiple, India is trading at 2.1x currently, which is similar to the level of 2.0.x seen at the trough of the cycle in 2002 and 2008."
This is an indicator of the extent to which the India market is already pricing in the adverse global environment and the current domestic situation of high inflation and slower trend GDP growth, it added.
The BSE benchmark Sensex on Friday soared by over 439.22 points to 17,429.98 on foreign fund inflows buoyed by the government's moves to revive the economy.
India's January-March 2012 GDP number was weaker than expected and Industrial production in April was broadly flat over the previous month and last year.
India's potential growth rate has taken a hit on the back of insufficient progress on deeper structural reform. Growth eased to 5.3 per cent as against 6.1 per cent in Q4, 2011 and the lowest reading since 2004.
Besides, inflation is still running high. May WPI rose to 7.55 per cent as against 7.23 per cent in April.
The report noted that despite the poor top-down domestic macro-environment, MSCI India is currently enjoying an improvement in relative earnings revisions versus emerging markets overall. In the year 2011, however, India had a weaker pattern of earnings revisions than emerging markets overall.
The brokerage said that mid-caps and small-caps are a better pick than large-caps at this moment and, sector wise, technology and consumer discretionary are their preferred sectors, while they continue to avoid state-owned banks.
The report, however, cautioned that India continues to score relatively poorly in relation to ownership position, dividend yield, political risk and corporate governance.
Morgan Stanley believes that India's external funding vulnerability during a period of USD strength and European bank deleveraging is a cause of concern.
Notwithstanding the risk factors facing the economy, some of the other foreign brokerage houses like Deutsche Bank and JPMorgan have also upgraded Indian stocks to 'overweight' from 'neutral'.
The Indian equity market has been through a pronounced period of under-performance recently. Several factors like the persistent downward revisions to GDP growth expectations, consequent negative revisions to earnings expectations and significant currency weakness have taken a heavy toll on absolute and relative performance of the stock market.
Meanwhile, the rupee has fallen by a whopping 20 per cent against the US dollar since mid-2011.