Cheer in the markets

The stock markets responded positively to predictions in the exit polls that the incumbent National Democratic Alliance government would easily win re-election. Over the course of trading on Monday, market indices hit new all-time highs and posted their biggest one-day gains in 10 years. The rupee appreciated by 49 paise, the biggest single-day gain in two months, to close at 69.74 against the US dollar. Some exuberance at the prospect of a stable government is understandable. However, it is relevant to ask whether an over-reaction to opinion polls — or even to the final results on May 23 — is a product purely of sentiment or a rational response to the underlying fundamentals. Naturally, markets will react to any new information, such as was delivered by the exit polls. But the possibility of some volatility following the actual results should not be discounted. The markets have already rallied considerably, so investors will know there is scope for a correction. 

The fundamentals deserve some attention. Emerging market shares have suffered as a result of renewed trade tension between the United States and China. Corporate India is still in the midst of its quarterly results season for the March quarter, but in spite of mixed results, analysts have pointed towards a trend of constrained demand. Analysts have reported a major shift in tone for the worse on the short-term demand narrative of companies reporting. Emerging from this situation will not be easy. Another brokerage firm reported that 60 per cent of the firms that it covered had reported lower-than-expected earnings. A demand slowdown in the automobile sector has received particular attention; and IT companies continue to struggle with their margins. It is not easy to identify the next big sources of earnings growth. Given that, and given also that the indices are already close to record levels, a certain degree of caution till the political and policy environment stabilises after the election seems warranted. 

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The question that will be asked on May 23 and after is: What the next government can and will do to support growth and earnings? If the markets are rising on hope, the new government has to deliver to keep that hope going. Once the noise around election results die down, the new government’s policy and reform agenda to stimulate demand, boost consumption, revive capex and revive economic growth will thus be closely watched. The experience after the NDA government’s assumption of power in 2014 was that there were no immediate big-bang reforms implemented. It is not likely that the first weeks and months would be any different this time even if the government were re-elected as the exit polls suggest. It will take some time to identify the policy priorities of the government, and even longer for those priorities to translate into action on the ground. Thus, any positive policy shock will take time to show up in the fundamentals. Till then, regardless of political volatility, the underlying trends of the market may well continue to be determined by broader, and global, factors. The trade and tariff war between the US and China, the developments in the Gulf and the prospects of a slowdown in the global economy are really as positive for the markets as the news from the exit polls.

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