How will the general Election Outcome Impact the Market?
In the coming days the hotly discussed topic in India would be the outcome of the general elections. From the stock market investor perspective, the crucial issue is: how will the election outcome impact the market?
Election Verdicts: Markets Can Get it Wrong
Markets are forward-looking and therefore, they discount the future. More often than not, markets discount emerging economic events correctly. But anticipating an election outcome, particularly in a complex country like India, is difficult. Markets are known to react hyper-sensitively to election outcomes, particularly when they are at variance with market expectations. In recent times this happened in 2004 and 2009. In 2004 when the Vajpayee-led NDA unexpectedly lost, the market crashed immediately, but smartly recovered when the reform-oriented Manmohan Singh Government assumed charge with market-friendly P Chidambaram as the FM. Again in 2009, the UPA victory without the support of the Left was unexpected and the market gave a big thumps up to the verdict. Globally, the market got Brexit and the Trump presidency wrong.
Coalitions have Delivered Superior Returns
A popular misconception in markets is that single-party rules are better than coalitions. In fact, the reverse is true. From 1947 to 1977 India had single-party rule led by the Congress. But the economy fared poorly during this period with a measly growth rate of 3.5 per cent. Poor growth and oppressive tax rates ensured low levels of corporate profitability. In the 1950s, 60s and 70s returns from the stock market couldn’t beat inflation rates. Hence, real stock market returns were negative. In the 1980s, with economic growth picking up, stock market returns started beating inflation rates, delivering positive real returns. The real breakthrough in economic growth, corporate earnings and stock market returns happened post 1991 when India entered the coalition era. Coalitions delivered superior GDP growth, earnings growth and stock market returns. The following data, detailing the stock market returns under various governments, is revealing.
It is important to note that in the long run, economic growth and corporate earnings drive the markets. Government’s economic policy and reform initiatives are important; but equally important, sometimes more so, is the external economic environment. During a benign external economic environment, even a lackluster government can deliver superior returns. The UPA 1 is a case in point. Indian economy and markets benefitted from the global economic boom of 2004-08 even in the absence of worthwhile economic reforms.
Earnings Growth is the Key
There is a lot of noise associated with the general elections this time. Warren Buffet advised long-term investors to “ignore the noise.” But the noise in the coming weeks will be too shrill to ignore. Therefore, listen to the noise; but without being swayed too much by it, and act with conviction. And this conviction should be born out of faith in the India Growth Story and the imminent pickup in earnings growth. The most important factor driving the market after elections would be earnings growth. And, there is very good news here. There is a near consensus that FY20 earnings growth will be above 20 per cent.
After tepid performance of the last four years, Nifty earnings are likely to spurt in FY20 led by corporate banks. This earnings spurt will bring the valuations into fair territory. Therefore, if the elections throw up a market-friendly government, it will be bullish times for the market. Recent market moves indicate that the market is already discounting a stable government. In the event of a badly-fractured mandate, a short-term sell-off is likely. If it happens, that can prove to be a good buying opportunity.
(The author is Investment Strategist, Geojit Financial Services)