Unstoppable is the strength of the Indian stock market. Despite high valuations, selling by FIIs, a slowdown in the global economy, and recent signs of some moderation in corporate earnings growth, it continues to roar ahead. Amidst a robust pre-election surge, the market is poised to persist its momentum until the electoral verdict. We can also expect a post-election rally if the results are in line with or better than forecast. However, it is rational to become a cautious investor in the short to medium-term because the volatility of the Indian stock market has increased during the year. The degree of outperformance of India, compared to the rest of the world, and midcaps to large caps is moderating. Furthermore, the gap between midcap premium valuations and large caps has once again reached record highs. While it’s still advisable to remain invested to fully benefit from the evolving Indian stock market, it’s important to expect modest returns in the short term and focus on maintaining a balanced portfolio.
Rolling on a pre-election rally
Presuming the onset of India’s pre-election rally on 3 December 2023, coinciding with the announcement of results for four state elections (MP, Rajasthan, Telangana, and Mizoram), the broad market closed with a 2% gain on that day. The election results seen as favorable for the current ruling party and indicative of the upcoming national election’s trajectory, ignited a strong performance in the subsequent one and a half months. The market continued to rally, resulting in an overall return of 11%.
| Current Pre-election Rally | 1st Dec 2023 Closing | 16th Feb 2024 Closing | Return (%) |
| Nifty 50 | 20,268 | 22,041 | 8.7 |
| Sensex 30 | 67,481 | 72,427 | 7.3 |
| Nifty Midcap 100 | 43,382 | 49,132 | 13.3 |
| Nifty Smallcap 100 | 14,239 | 16,194 | 13.7 |
| Nifty 500 | 18,115 | 20,165 | 11.3 |
Estimating that the final-result will be in the months of May-June, we can expect the pre-election rally to sustain for the next three to four months with a positive bias. Historical election-year data suggests favourable outcomes for India in both pre- and post-election rallies, regardless of the election result. However, it’s crucial to note that the overall returns depend on various other factors at that time, including geopolitical situations, the performance base from the previous year, global economic factors, and domestic earnings growth.
Past election years’ performance
| Sensex | 6month pre-election (%) | 6month post-election (%) | Total (%) |
| 1999 | 33.8 | 1.0 | 34.8 |
| 2004 | 7.0 | 11.3 | 18.3 |
| 2009 | 29.7 | 38.4 | 68.1 |
| 2014 | 17.2 | 17.3 | 34.5 |
| 2019 | 11.8 | 3.2 | 15.0 |
| Average | 19.9 | 14.2 | 34.2 |
The broad market is up by 11.8% in the pre-election rally of the last two and a half months. And the broad market has demonstrated robust performance over the last three years, achieving a CAGR of 17.64%. Looking ahead, it’s improbable to expect a similar rally due to elevated valuations, which present a significant risk for the market, particularly considering the anticipated moderation in corporate earnings growth for 2025-26.
Premium valuation of mid and small caps
To sustain the rally, the mid and small caps must maintain their good run, which is a challenge since they have been trading at a premium valuation for an extended period. Currently, midcaps are trading at a premium of 40%, which is more than double the 10 years average of 17%.
It makes sense to invest in large caps and value buying on a stock-to-stock basis. A reduction in midcap exposure is warranted in a retail investor’s portfolio.
Volatility is trending upon domestic economic musings
The volatility of the Indian stock market has increased in the last month, but the market is able to hold on to the gains. The India VIX index has increased to 16.2x from 13.86x a month ago. It is a combination of both global and domestic factors. Globally, speculation surrounding the timing and magnitude of the season’s first rate cut by the Fed, coupled with selling pressure from FIIs in emerging markets, plays a pivotal role. Domestically, factors such as the Q3 results announcement, interim budget, the pre-election rally, the RBI’s tight policy, and a high level of margin funding contribute significantly to the heightened market fluctuations.
Despite encountering various challenges, the market has managed to surpass them and is now trading in a new high zone. While there has been a broad-based recovery, there is a sense of caution among market participants, leading them to favour quality large-cap stocks due to the existing valuation gap. Though, mid and small caps have outperformed in the last one month, the degree of outperformance has reduced. We prefer large caps as a medium-term investment strategy.
In the current short-term scenario, it is expected that volatility will rise as the upcoming major event of the election draws closer. The ongoing robust pre-election rally forecast is likely to continue until the day of the election results, and then may take a breather. Corporate Q3 results are healthy and in-line with expectations, nevertheless indicating a slowdown in earnings growth on a quarter-on-quarter basis. Similarly, the forecast for FY25 is moderate compared to FY23–24. Recent volatility in the global market has also intensified, primarily due to speculation surrounding a potential Fed rate cut in May. These factors will play a crucial role in determining domestic market movements in the short term, particularly given the high valuations. India has been holding the premium valuation for more than three years and is currently trading at plus 20x one year forward earnings.
