Impact Of Three Possible Outcomes

The preceding issue of Dalal Street Investment Journal carried a very interesting editorial from our Editor-in- Chief. Just to put things in perspective, it talked about something that seems very inevitable in the present political circumstances. Let’s begin by reproducing some part what was mentioned in that editorial. This will serve the purpose of laying the context for this story.

The ongoing election he had said ‘has offered an opportunity to the voters of this country to change governance for their own benefit. The hope of a strong, stable and decisive government with a leader of integrity and charisma at the helm of its affairs is the need of the hour. From this hope has sprung a phenomenon called Narendra Modi (NaMo). The impact this one man has created so far seems unparalleled. The entire political theatre has woken up to his war cry and is today in a mad scramble to ensure he doesn’t get to the Prime Ministerial chair.’

However, ‘more closer we get to D-day, more it looks like the man is destined to occupy the most coveted office in the country. The point to ponder over is, whether it is Modi alone who is to be credited for this change. Well you could argue against this, but you certainly cannot miss the point that a strong leader with a strong mandate is what people have been missing for over 10 years now. Modi is filling up that vacuum by a good margin.’

‘According to a study conducted by us, far above the 275 seats (the highest so far indicated for the NDA) we expect the combine to win as many as 313 seats on the lower side of the estimate’ we had said. ‘A clear majority for the NDA will mean a lot at this stage. Growth has come to a virtual standstill and the confidence of the investor, big or small, stands shattered. With hope building on the above scenario taking shape, that confidence is gradually coming back. Markets are hovering at their all time high levels, a boost in business confidence coming from a victory for the Modi-led government could see them get into an altogether new orbit.’

What is stated above seems to be more than obvious to the open Indian mind today. But as they say ‘the elections aren’t over until the last ballot is counted’. That brings us to debate on the other scenarios that could pop up on the 16th of May 2014. These scenarios could well mark a turnaround in the future of the nation.

India is not new to politics of coalition. The days of an absolute majority for any one single party are a thing of the past. With regional political outfits gaining strength, the compulsion of striking alliances has only become stronger as years have passed by. Since 1989 multi-party governments have ruled the nation giving way to a lot more regional participation at the centre, 2014 is no different. Pre-poll alliances are already in place and the way the equations stand, certainly no single party can come to power.

The two principle factions that are leading the race are the NDA and the UPA. These two mega alliances which comprise of 29 and 11 parties respectively have been slugging it out big time. The UPA in its second term has faced a lot of flak for all the mess and mismanagement of national resources for the personal benefit of some of its leaders. The NDA on the other hand is banking on the image and persona of Narendra Modi, a phenomenon that was born out of the sheer need for a strong, decisive and charismatic leader to head the nation. The momentum that the ‘NaMo’ mantra has created for the BJP and hence the NDA is so strong as of now that the alliance coming to power is assumed to be a given in the present circumstances. That brings us to the first scenario that is currently looking very obvious.

Scene I 

The Optimistic Scenario (300 + Seats for the NDA): A change in the voting pattern which has seen a huge turnout (an average of 70 per cent) as against what was witnessed in 2009 or even the earlier elections has a majority looking at this scenario to materialize. The NDA which comprises the BJP and its allies is contesting all the seats. The BJP is trying its luck in 428 of the 543 seats while its allies are contesting in the remaining. On a standalone basis if the BJP cracks the code and gets to the magical number of 272, its allies winning another 25 to 30 seats should help it sit in a commanding position in the 16th Lok Sabha. This may seem to be too ambitious, but the way things are, a possibility of it cannot be ignored.
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Scene II 

The Most Likely Scenario (272 Seats for the NDA): This is the most ideal scenario that could emerge on D-day. The murky past of the UPA II has more than ensured a strong anti-incumbency wave. Add to this the NaMo factor and the NDA as of now, looks comfortably placed to reach the 272 figure mark. With the BJP contesting 428 seats and its allies another 115 seats, this equation of the combine winning at least 272 seats is very close to reality. Given the planks of development, clean governance, and strong leadership that these elections are being fought on, a 50 per cent success for the BJP and its allies looks given. Even in this situation, the NDA will still be in a position to run the treasury without having to deal with much of a nuisance of the opposition. The problem (if at all any) could arise at the time of distributing cabinets and departments among its allies and itself. Being in a crucial position, demands from allies would have to be met in order to ensure the smooth running of the government. This has been an uphill task for past coalitions, but here is where the leadership angle comes into play. With Modi at the help, you could well be ensured that the remaining leadership too falls in place to ensure what the electorate has voted them in for. That brings us to the third and the most undesirable outcome of these elections.

Scene III 

Scene II NDA 272 Scene III NDA <200 The Worst Case Scenario (Just about 200 Seats for the NDA): This is a very rare but fearful scenario. Anything below 200 seats for the NDA means a non-NDA government will have to be sworn in. Now this does not necessarily mean that a Congress led UPA could come to power once again. With the Congress and the UPA sinking, it could well pave the way for another third-front government coming to power. The bunch of parties that could come together to form the third front is such that can send chills across many a spine. That also throws open another possibility; the UPA striking a deal with the third front for outside support and forming a lame-duck government. This virtually means another election within a short span of time.

Having looked at the three possible scenarios, here is what they could mean for the economy and hence the markets. In the time that has elapsed between the announcement of the elections and now, the markets have run up quite a bit. The slow but steady grind of the market on the up side has been out and out baffling. Benchmarks have been hitting new highs with every passing trading session. Fundamentals have been swept under the carpet with global cues having only a limited impact at least for now. Every big issue which was getting on to the nerves of the market only a couple of months ago is just not visible on the horizon as of now.

The only factor on which the markets have remained focused over the past couple of months is a change in guard with a stable government assuming office. Optimism has graduated into euphoria and put the markets into a new orbit. But this one sided march of the market to the top has to be looked at in the correct perspective. Right now, the question to relate to is ‘what’ rather than ‘who’. It is more important to look at what will the new government bring in rather than who will come in.

The equity markets are looking at a stable government with a clear focus on the reforms process. It was the policy paralysis that affected the growth rate as whole and ultimately other macroeconomic fundamentals over the past five years. Hence it is of the utmost importance that the new Government focus on the reforms process and that too at a rapid pace in order to instil the lost confidence back into the system. It is true that things would not change overnight. However one needs to understand that the equity markets usually run on expectations as the investors discount future prospects more than the past performance. While this is one aspect, another important aspect is that of valuations.

But before touching upon these two, here is a historical perspective. In the past, though the markets have reacted to elections and their outcomes, the effect has usually remained short lived. Just to put the figures in perspective, in May 2004 the markets had reacted negatively (hitting a lower circuit) as the UPA 1 came to power, even after the blistering performance of the NDA Government in its tenure. The major reason for this was the coalition of UPA with the Communist parties. With many on the street looking at the communist parties as a roadblock for growth rates, selling had been relentless. In 2009 the reaction was exactly the opposite. The markets hit the upper circuit on the announcement of election results. The reason was that, the Congress had emerged as a single largest party and almost got the required numbers. Stability was expected over the next five years.

While the market’s reaction was almost polarised the impact of the election results only remained for a few days, after that fundamentals took over the markets. While the markets reacted negatively to the 2004 poll outcome, they recovered smartly as economic growth rates remained significantly good. It was no wonder hence that the markets witnessed a good bull run.

Exactly opposite to this, in 2009, the poll results saw a huge positive reaction in the markets. However, eventually GDP growth declined and so did the financial performance of India Inc. The rest is history. Policy paralysis affected the markets so badly that the sluggishness took its toll on the financial health of the economy in general and businesses in particular.

Hence, though election results may affect the market in the shorter term, ultimately fundamentals will drive them.

So, while it is important to understand the poll result and political equations, it is also important to understand the valuations at which Indian markets are likely to trade. As stated earlier, it would depend on the agenda of the new government and have already discussed the three different scenarios of political equations that could develop.

The Sensex at 22600 is currently trading at 18.25x its trailing four quarter earnings. This is despite the fact that markets are almost trading at all time high levels and financial performance of the India Inc has been below par.

Things are actually changing for better as the macroeconomic scenario is improving. The Q4FY14 results have been better than street estimates till date. Considering the same, there are likely to be Sensex and Nifty EPS estimate upgrades for the FY15 and FY16 as well. According to consensus EPS estimates for FY15, the Sensex EPS is expected at Rs.1542 and for FY16 it is estimated in the range of Rs.1790-1800. Considering these, currently the Sensex discounts its FY15 earnings by 14.70x. This is in-line with the historical forward P/E enjoyed by the markets and also provides some amount of room for an upward movement.

So, in case Scene I gets enacted, you could see the market spurt up in heightened enthusiasm only to come back to its senses in a couple of weeks. This could see the benchmarks go off the roof but fall back to real levels once the euphoria subsides. Investors could well do with ignoring that euphoria and remain on the sidelines to pick up stocks at more realistic levels going forward. Even a stable government with a focus on growth would mean that the markets remain at higher levels (Scene II as depicted above).

Time will bring into play some very simple facts. This will include the time needed for the new government to act and yield results on its actions. But the worst fears for the markets are with Scene III being enacted. It could spell doom in every sense of the word for the economy and the markets. Already trading at such high levels, it could well not even offer a chance to offload the high stakes that are being built by investors. The time between now and D-day would well be a period where smart investors try and rationalize their portfolios to be fully prepared for any eventuality that may come their way.

While we have discussed on the market valuations, investors would be interested in knowing which sector would benefit more after the poll results announcement. Considering the economic and social agenda of the different parties, we are here providing a few sectors that would benefit more.
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Infrastructure (Road Projects and Water Management)

Infrastructure is a sector which creates the highest number of job opportunities. Even a rupee invested in this sector generates opportunities worth Rs.10. This means that the capital gearing is the highest here. In the past we have seen that the NDA has always focused on the infrastructure segment. With the NDA currently being the favourites to win the elections infrastructure stocks are likely to remain vibrant. Especially road projects and the water treatment companies are likely to be major beneficiaries. Even the UPA Government has understood the importance of infrastructure and even if they come to power the focus would remain on it. Rather restarting stalled projects is high on its agenda. It has gone on record to state that it plans to build on the success of the Cabinet Committee on Investment and the Project Monitoring Group in clearing stalled investment proposals and set up the National Investment Facilitation Authority, headed by the Prime Minister.

In addition both the leading factions would be focusing on connecting million-plus cities by High Speed Rail and completion of the Western and Eastern Dedicated Freight Corridors. The infrastructure sector has underperformed for a long period and hence many stocks are available at throw away valuations. As the results outcome becomes known, we expect strong momentum in the infrastructure sector stocks.

Realty
Realty has been reeling under the burden of debt and slower sales volumes. Slower GDP growth and higher interest rates have made matters worse for the sector. With all the leading parties having an action plan to improve the macroeconomic factors (especially inflation), the interest rates situation is likely to improve and this will be beneficial for the sector as a whole. But what will really boost the sentiment of the sector is the creation of newer cities. While the BJP has planned for 100 new clusters even the UPA has planned the creation of a similar number of new cities. This is a good opportunity for the realty companies. However, it needs to be seen how many of the currently listed companies would manage to survive the present scenario to look beyond it. Further, the land acquisition bill also is a major road block for many of companies. There is an instant need of making some amendments to this bill if it has to yield any good results.

Banking
Banking is one segment which is already getting some traction. As the new government comes into action, there is a lot expected on the banking reforms front. While the process of new banking licenses has already begun with two entities already getting licences. The sector is still facing issues like higher non– performing assets. This again, is more due to do the poor macroeconomic situation. As a new and stable government gets formed, the situation would improve for sure. But the only problem area is, the UPA government has kept providing low interest rate loans to farmers. In the past we have seen PSU Banks suffer a lot and get bogged down by Agriculture loans to the tune of Rs.60000 crore being written off.

Healthcare
India still lags on the healthcare index and a lot of investment is needed in it. With the UPA government planning to increase its healthcare spending to 3 per cent of GDP, the BJP is also not far behind in that matter. We feel the healthcare sector in India has been witnessing good growth and public spending on the same would only result in accelerated growth. These are few of the sectors that emerge as a winners based on the agenda of different parties.

However there are going be winners and laggards amongst the sectors. A few of the stocks have already witnessed a rally and few are still available at good valuations. So, based on their own prerogatives investors can buy stocks from the sectors mentioned above.