The landslide victory of the BJP in Uttar Pradesh and Uttarakhand will bolster the already upbeat sentiment in the stock market.
Foreign and domestic investors who have been supporting the market rally will interpret the win as an indication that economic policy reforms will get an impetus.
The likelihood that the BJP is a strong contender in the 2019 Lok Sabha elections will also be taken positively by foreign investors, who prefer continuation and stability in policy-making.
Yet, a sustainable rally in stock prices from current levels is not a certainty.
The Indian equity market has been one of the better performers in 2017, with both the Sensex and the Nifty up 10 per cent since the beginning of this year.
Indian benchmarks have outperformed almost all their peers in China, Indonesia, Taiwan and Thailand.
One of the reasons driving the stock price rally in recent times was the expectation of a strong showing by the BJP in the Assembly elections. Though a poor showing by the ruling party might have led to a sharp sell-off, the win is not take likely to take stock prices much higher since the positive impact could have been priced in already.
Equity markets have also been enthused by macro data and company earnings in recent months that showed that demonetisation had a negligible impact on the formal sector. But the rally has made stock valuations rich.
Also, global events such as the US Federal Reserve’s next move on interest rates and crude oil prices could play a larger role in determining stock market movements.Rightly valued
The rally over the last two months has made stocks pricier than they were at the beginning of this year.
The Sensex is currently trading at a trailing 12-month price earning (PE) multiple of 21.4 times and around 16 times its FY18 earnings estimate.
While these valuations do not take stock prices into bubble territory yet, they aren’t cheap either. The argument in favour of a further rally is the strong showing by listed companies in the December quarter.
While revenue growth of companies (excluding banks and financial companies) was close to 10 per cent, profit growth was close to 30 per cent.
Further, there is an expectation of listed companies continuing to deliver good numbers next fiscal, too.
The consensus estimate on Sensex earnings growth in FY18 is 20 per cent, with metals, engineering companies and banks turning the corner on the profitability front.The liquidity factor
While the domestic scene is all right, fund flows into the equity market could throw a spanner in the works. Foreign portfolio investors (FPIs), who were net sellers from last October, turned net buyers in February.
They have pumped in ₹18,000 crore in Indian equities so far this year. But with the Federal Reserve all set to hike US interest rates by 25 basis points (bps) this week, the guidance regarding future rate hikes will determine short-term foreign fund flows.
If there are outflows from emerging market funds, Indian equity can also be impacted. Outflows can also be triggered if the US stock market, which has been in a sustained rally since November, begins correcting.
A factor favouring higher FPI inflows into India is crude oil prices. Crude oil futures dipped below $50 a barrel last week as inventory levels rose due to higher US shale oil production and OPEC members not sticking to their targets. If prices fall further, India stands to benefit as a net crude oil importer.