In a fortnight, India will start voting to elect a new Central Government. High-decibel campaigns to woo voters, tie-ups and break-ups among political parties, bickering over seats and tickets, name-calling, opinion polls — the dance of democracy is well under way.
The stock market, always a quick mover, seems to have caught election fever early. Over the past year, despite anaemic economic growth, high inflation and weak corporate earnings, the Sensex has notched up a neat 16 per cent gain. Initial signs of an economic recovery have played a key role in this rise.
The feel good factor in the market on hopes that the BJP will emerge tops in the coming elections has also helped. Since early December, the Sensex is up more than 5 per cent — aided by the BJP’s good performance in State elections last November-December and many opinion polls predicting it to be the front-runner in the general elections.
Many market players feel a BJP-led NDA Government steered by Narendra Modi will be more decisive, accelerate reforms and propel economic growth.
Amid the excitement, how should you, as an investor, play the elections?
Keep some powder dry First, don’t raise your bets on stocks in the hope of making hay while the sun shines.
It could prove risky. Data from the past few elections shows that pre-election rallies and losses did a complete u-turn in the months or even years ahead.
Consider the 2004 and 2009 contests. In the year running up to the elections in April-May 2004, the Sensex almost doubled. But contrary to expectations, the ‘India Shining’ campaign did not deliver for the NDA. The UPA wrestled power with the support of the Left parties, which were perceived as market-unfriendly. A disappointed market pushed the Sensex down 16 per cent in May 2004. This, however, was temporary; the market recouped over the year and the Sensex then went on to quadruple over the next three-and-a-half years till 2007-end.
Copious foreign funds and an economy in the pink of health (those were the go-go years with 8-9 per cent annual growth) propelled the rise.
The global financial crisis of 2008 then sent the Sensex crashing from 20,000 to sub-10,000 levels by early 2009, the next election year.
The markets went into that election with a 34 per cent fall in the Sensex over one year. But a convincing win for the UPA, which again formed the Government (this time without the Left parties), saw the Sensex gain 28 per cent in one month. With the economy improving, the index continued gaining, going up 40 per cent to the 20,000 level again by end 2010.
But then, a spate of scams, policy logjam, economic slowdown, high inflation and the rupee’s rout tripped the Sensex.
Only since last September have the economy and the Sensex started regaining their mojo.
This shows that while elections may move the needle in the short term, it doesn’t take much time for fundamentals to re-assert themselves. Today, with the market poised at an all-time high, caution is warranted. In the worst-case scenario - a fractured mandate and an unstable Government - the market can tank significantly.
If a BJP-led Government does not fructify, again the market is likely to react badly.
On the other hand, with this rally powered entirely by hopes of a BJP win, there may be no surprise factor if BJP does get a thumping victory.
This suggests that the best course of action would be to go into D-day with plenty of cash and debt in your portfolio.
Be selective on cyclicals
Cyclical stocks have led the recent leg of the stock market rally since December, with sectors such as capital goods, banks, and consumer durables (8-16 per cent returns) outpacing the 5 per cent gains in the Sensex. This has been fuelled by two factors.
One, the economy, on its own, is showing some signs of coming out of the woods — the current account deficit is well under control, inflation has been easing somewhat, economic growth has inched up a bit, the Government has stepped up project approvals, and the rupee has recovered.
Corporate profits also seem to be on the mend.
In the December 2013 quarter, profits of the S&P BSE 500 companies (excluding PSU oil and gas companies) rose about 11 per cent year-on-year — a turnaround from the earlier three quarters when profits fell.
This has contributed to robust gains since December in stocks such as L&T and Axis Bank, which are up 17 per cent.
Two, the market is pinning its hopes on a BJP-led Government to accelerate economic growth by intensifying the reforms process and expediting project approvals.
This has sparked off swift gains in capital goods and infra stocks such as BEML (up 40 per cent), KEC International (37 per cent), GVK Power and Infra (35 per cent) and Adani Ports (17 per cent).
But accelerating reforms or expediting projects stalled by environmental concerns isn’t likely to prove easy even if a pro-market Government is formed at the Centre.
Thus, this is the time to capitalise on recent gains and book profits on heavily debt-laden companies and those which face risks due to project delays. Stocks such as GMR Infra, Adani Power, Lanco Infratech and HCC fall under this category.
Also, even a proactive Government may not be able to immediately address some of the serious troubles faced by companies owing to judicial intervention, lack of State level clearances or changes at the global level.
In essence, it is best to keep away from those cyclicals which are subject to policy uncertainties and legal restrictions; they may not immediately benefit even if the economic cycle turns.
You can consider taking bets on cyclical sectors and stocks that need less policy intervention and can bounce back automatically when an economic recovery sets in.
Sectors such as banks, autos, consumer durables and cement fit the bill.
Good picks in this category include commercial vehicle makers such as Ashok Leyland, PSU banks such as Bank of Baroda and SBI, consumer durable companies such as TTK Prestige and Bluestar and cement companies such as The Ramco Cements and UltraTech Cements. The country’s leading infrastructure developer L&T and engineering consultancy Engineers India are also good choices at this juncture. These stocks are trading at reasonable valuations.
Also read: Give politically connected stocks a wide berth
Don’t shed all defensives In the recent run-up in stock prices, defensive sectors such as pharma, software and fast-moving consumer goods have taken the back seat.
But don’t get tempted to abandon them in favour of those with the wind in their sails.
Valuations of some defensive sectors remain lower than their historical levels.
The S&P BSE IT Index, which sports blue-chips such as TCS and Infosys, is at 17.5 times its trailing one-year earnings, as against 20 times in March 2012. Also, the BSE Healthcare index is at 22 times, compared with 31 times two years ago.
If the verdict in the elections fails to meet the market’s sky-high expectations, this may once again send cyclical stocks to the doghouse and increase the appetite for defensives.
Also, while the Indian economy seems to be on a mend, a return to high growth is unlikely to happen in a hurry.
Even if a stable Government presses all the right buttons, there will be a time lag between announcements and results to show on the ground.
Add to the cocktail global uncertainties such as the Russia-US standoff over Ukraine, a slowdown in China and a US rate hike. You get the picture, right?
Bet right, sit tight
Don’t go overboard on equities
Keep cash ready for buying opportunities after elections
Avoid sectors that need major policy or legal relief
Buy sectors such as autos, banks and durables
Book profits on debt-laden stocks
Don’t let go of your defensives
Also read: Don't bank on opinion polls