Unclear messages from the electoral tea leaves

By Gautam Chhaochharia
December 17, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

The past 12 months have been characterized by the narrowest market in two decades although sectoral performance varied significantly. While the markets are likely to be range-bound, valuations are expected to rise in 2014, especially in the first half.

Based on a one-year forward PE range of between 12.5 and 15 times and our top-down FY15 earnings growth forecast for the Nifty of between 10 percent and 15 percent, we expect the index to trade between 5,500 and 6,900 in 2014, with a target of 6,900 — an implied increase of around 10 percent relative to current levels.

National elections will take place before May 14 next year. Historically, a surprise outcome has moved markets by between 15 percent and 20 percent either way.

Based on Narendra Modi’s strong governance track record and his reputation of being pro-industry, investors are positively inclined towards the BJP. They are less inclined towards the Congress despite policy course corrections. The recent rally implies that markets no longer view a BJP victory as unlikely — a factor that may be priced in from a near-term perspective.

A new government of any political persuasion will seek to correct the economy but, of course, the direction of the market before and after elections may differ.

In the recent assembly elections in Chhattisgarh, Delhi, Madhya Pradesh, and Rajasthan, the BJP either won outright or has the highest number of seats. In the last two elections, performance in local elections in these states was mirrored in subsequent national election results — vote share increased for the winning party.

However, it is important to note that these states contribute just 13 percent of total parliamentary seats. State elections are also, typically, fought on local issues and so may not be an accurate reflection of national sentiment. While the results do not necessarily indicate that Modi or the BJP can expect a shoo-in victory next year, they are indicative of the anti-Congress mood. Unlike the last two state elections, when the results were mixed, the BJP prevailed in all four states this time.

It remains a political imperative for the current government to tame fiscal deficit and inflation, although the street continues to expect pre-election spending. This had shown up in the government’s measures to curtail fiscal deficit over the last four quarters but the focus on inflation appears to be gaining more political backing. The stance taken by policymakers — the Reserve Bank of India and both the incumbent and incoming government — will be a key factor in repairing the economy.

While tapering is not a fundamental issue for India, the depreciation of the rupee may remain a trend: more than 30 percent of Nifty earnings derive in part from a depreciating currency and it has the potential to provide stability for earnings. The expectation of a structural improvement in demand underpins our overweight IT services call. And while a good monsoon is a green shoot, its macroeconomic impact may be limited.

We are neutral on rural-focused consumer staples but underweight on two-wheeler makers. Fiscal consolidation is likely to slow growth in the first half, implying things will get worse before getting better. We are underweight on the consumer discretionary sector. Cyclicals (industrials, infra and PSU banks) may also be hit after the recent rally.

The investment cycle may take a long time to recover but the building blocks are being put in place. It is too early to bet aggressively on industrials; we are overweight on private banks and defensive power sector stocks that are estimated to offer better risk-rewards in 2014. The monetary cycle appears more inflation-focused: positive for the economy in the longer term but a possible impediment for rate-sensitive stocks in the near term.

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