It’s election time. For the next more than two months, elections will dominate the national agenda. The market, too, will be influenced by political developments and trends. How should investors respond to the emerging political developments?
Elections started influencing the stock market significantly after 1989. During 1984-89, India had single-party rule by the Congress under the leadership of Rajiv Gandhi. Rajiv’s initial dose of liberalization had pushed India’s growth rate to 5.6 percent. For the first time in India, the stock market gave inflation-beating returns in the 1980s. Sensex gave 21 percent CAGR returns in the decade 1979 -89. Economic growth, corporate earnings, and stock market returns started accelerating after the initiation of liberalization in 1991 by the coalition government headed by Narasimha Rao. The Sensex which was around 1000 in 1991 has multiplied 72 times since then, giving impressive returns to investors. As the stock market indices moved up, volatility, too, has been higher. Since economic policy became significant after 1991, the political stance of various parties and coalitions also became significant. Markets responded strongly to elections and political developments.
Pre-election rallies are normal in the run-up to the elections. This has happened in all the last five general elections. In all the previous five elections, the market started rallying around six months in the run-up to the elections. The rallies in the run-up to the elections ranged from 3.1 percent before the 2009 elections and 36 percent in the run-up to the 1999 elections. In 2004 the pre-election rally was 9 percent and in 2014 and 2019, the rallies were 14 percent and 19 percent respectively. In post-election rallies, an outlier was the 2009 elections, which led to a 36 percent rally after the elections.
Market doesn’t have a preference for any particular party….
The stock market doesn’t have any preference for a particular political party. Market’s clear preference is for liberal, pro-market policies. That’s why, when the UPA government under MM Singh got a better-than-expected mandate in 2009 and was in a position to rule without the support of the Left parties, the market opened circuit up, followed by one more upper circuit and the Nifty ended the day with a gain of 17.3 percent. The Left parties were the stumbling blocks in the way of liberalization in the UPA 1 regime and when the UPA got a majority without the support of the Left, the market gave a thumbs up to the mandate. Clearly, the market had a very positive view of Manmohan Singh as the prime minister and P Chidambaram as the finance minister. More important, the election outcome was unexpected and, therefore, not discounted by the market.
………….but prefers political stability
That said, it is important to note that the market has a clear preference for political stability. This is because political stability ensures continuity in policy. The market abhors uncertainty.
Political uncertainty is less in 2024
The major difference between the previous five general elections and the 2024 election is that uncertainty is much lower this time. Election surveys are far from accurate, but they indicate a broad trend. There is a near consensus now that the BJP/ NDA will come back to power after the 2024 elections. The uncertainty is only regarding the number of seats the ruling party will get.
The market has already discounted a BJP/NDA victory in the elections. This is evident from the 1387-point rally in the Sensex when the market opened on December 18th after the results of the four state elections were known. Since the state election results were much better than expected for the ruling dispensation, the market rallied smartly, partly discounting the results of the 2024 general elections. Post- the state election results; Nifty is up by more than a percent clearly indicating a pre-election rally.
High valuations may restrain the rally
Valuations will restrain a sustained rally in the market. At 22000 Nifty the market is trading at 22 around times FY 24 earnings. Considering India’s growth potential, these are not bubble valuations, but certainly elevated valuations in comparison to historical averages. More important, in the mid and small-cap segments valuations are excessive and, in some pockets, frothy.
Explosive growth in the number of demat accounts, retail investor enthusiasm and sustained flows into the market through DIIs have the potential to keep valuations higher for an extended period of time. But at higher valuations, risks are higher, and the market will be vulnerable to sharp corrections. In brief, there is no room for a runaway rally from the present levels. If that happens, the market will enter a risky euphoric phase and investors will have to be cautious.
