Understanding the election result event risk…


In the last two-three months, Indian equity market has been exuberant due to higher liquidity from FIIs while inflows from domestic institutions and retail investors have been subdued. Though FII inflows have been positive, all types of investors are waiting for the final electoral decision, given that the high political drama will have a short to medium term impact on the market.

We feel that, if there is a clear and strong majority in the election result, it will have a positive reaction in the market extending the pre-election rally due to higher inflows from FIIs and Domestic institutions. FIIs have been very positive on emerging market YTD, but in this, India was underperforming with a dollar-based return of 5% while MSCI-EM index is up by 10% led by China and Russia with 20% return. FIIs too have been waiting for the final decision and they will be inclined to invest more in India post this event risk with clarity on whether there will be continuity in reforms and measures as seen in the last tenure. At the same time performance of India was also impacted due to dearer valuations led by lack of earnings and economic growth.

In case there is no clear majority, the reaction of the market may be neutral to marginally negative in the short-term.  Because this situation is well factored in the market and the recent economic data has been weak, it will take another two to four months for the market to stabilize. The ongoing Q4 results has started on a low note, it is marginally below the expectations leading to further downgrade in earnings and de-rate in valuation. These factors will start to control the market’s momentum post the event day, leading to minor consolidation.

A worst-case scenario is a weak coalition which is very unlikely as per the consensus of pre-election survey. In any such cases, the reaction of the market will be negative leading to thoughtful consolidation in the short-term. The sustainability of the ongoing pre-election rally will depend on the strength of the government and start of economic growth. Being stock specific with a bottom-up-approach and choosing quality names and brands will be a safe investment strategy in such times.

In overall, the impact of the election outcome is likely to be short-term in nature, ranging between +/- 5 to 15%. These will generate arbitrage and trading opportunity in the next two to three weeks. Traders may play according to the momentum of the market which is currently negative, the final direction will depend on the election outcome.

In the medium to long-term there are strong possibilities that interest rate in India will reduce given the structural reform of the economy, improvement in NPA issue and reduction in consumer inflation.  Stability in business post-election, potential rate cut and higher inflows in equity led by supporting measures of FED, ECB and RBI will help the market during H2CY19. The sectors which will perform well in all these cases are financials, in which private banks and corporate lenders will outperform, cement due to good growth in volume and prices, chemicals due to brighter business outlook and contrary bet like pharma and infrastructure due to attractive valuation.

Posted: May 9, 2019


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