Sensex@39K: Beware! Tactical trade is pushing up this market
It is being argued that the market is discounting a market-friendly election outcome.
Earlier this year, emerging markets were languishing amid fears of continuation of rate hikes by the US Fed. The consensus was that the Fed would raise rates three times in 2019 on top of the four hikes of 2018.
The FOMC meet of January 30 completely changed the scenario for capital flows. The Fed not only kept the rates unchanged, but also declared that ‘further rate hikes are on hold’. Later, ECB also announced a dovish monetary stance. The dovish stance of the two leading central banks of the world along with monetary stimulus being implemented by the People’s Bank of China have unleashed a gush of liquidity chasing risky assets like emerging markets equity. Dollar carry trade is playing a major role in this liquidity-driven rally in EMs. In brief, this is a tactical trade divorced from fundamentals.
The ‘risk on’ rally triggered by the liquidity flows has fuelled a global bull rally. By March end, the MSCI All Country Index was up by nearly 12 per cent and MSCI EM Index 9.50 per cent for the year. Developed markets have done better with the MSCI US Index up 13.22 per cent and MSCI EMU Index up 11.57 per cent.
It is interesting to note that while MSCI Emerging Markets Index was up 9.50 per cent, MSCI India Index was up by 5.71 per cent only. This means we have some more catch up to do. After the sustained outflows witnessed from India in 2018, FPI inflows have turned robust in 2019 with year-to-date inflows of more than Rs 46,000 crore.
It is being argued that the market is discounting a market-friendly election outcome. Some market players are betting on NDA’s return of to power. Even though this might be the likely scenario, it appears to be a bit premature.
Election verdicts: Markets can get it wrong
Markets are known to react hyper-sensitively to election outcomes, particularly when the outcome is at variance with market expectations. In recent times this happened in 2004 and 2009. In 2004 when the Vajpayee-led NDA lost unexpectedly, the market crashed immediately, but recovered soon after when the reform-oriented Manmohan Singh government assumed charge with a market-friendly P Chidambaram as Finance Minister.
Again in 2009, when UPA won without the support of the Left, the market gave a thumps-up to the “game changing election outcome.” But, in retrospect, it would be right to say the market was wrong in its assessment since the UPA-II, which was expected to usher in reforms, got embroiled in a series of scams and policy paralysis. In brief, the market can be wrong in its anticipation, knee-jerk reaction and short-term assessment of election outcomes.
Coalitions have delivered superior returns
A popular misconception in the market is that single-party rules are better than coalitions. In fact the reverse is true. From 1947 to 1977, India has 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 have 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 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 lacklustre government can deliver superior returns. The UPA-I 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 key
There is a lot of noise associated with the general elections this time. Warren Buffet always advises 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, 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 that would drive the market after elections would be earnings growth. And, there is good news here. There is a near consensus that FY20 earnings growth will be above 20 per cent.
After tepid performance of last four years, Nifty earnings are likely to spurt in FY20 led by corporate banks. This spurt in earnings will bring valuations into the fair territory.
Therefore, if the elections throw up a market-friendly government, it will mean bullish times for the market. In the event of a badly fractured mandate, a short-term selloff is likely. If it happens, it can a good buying opportunity. It is also possible that the market may discount the election outcome much earlier than the event. Calibrated accumulation of quality stocks should be the ideal investment strategy, going forward.