Punting on election results is risky; focus on fundamentals instead

A bottom-up approach of investing in select stocks that are witnessing earnings recovery is the prudent course for the current markets

The equity markets were volatile both, around the exit polls and when the actual election results were announced. The Sensex rose 3.75 per cent on the day the exit polls (May 20) were published, but lost 0.97 per cent the very next day. On the day the election results appeared (May 23), the markets zoomed to an intra-day high of 40,100.5, but then promptly gave up those gains during the second half and ended 0.76 per cent lower for the day. Unless a trader was able to time his entry and exit around these events to perfection—which is no mean feat—he may well have ended up with losses in such a volatile environment.

For most retail investors, who also hold day jobs, punting on such events as exit polls and election results can be risky. A long-term, fundamentals-based, buy-and-hold approach will serve most retail investors better. Those who do not have the time to do their own research should take the mutual funds route.

Expect a near-term pullback: The markets’ quest for political continuity, which has been fulfilled by the Narendra Modi-led Bharatiya Janata Party’s (BJP) return to power, will provide a feel-good factor. However, now that this major event is behind us, market experts expect a pullback. “We may see a sell-on-news kind of phenomenon. Participants may book profits as the key event is over and there is no further trigger in the near term,” says Rajesh Cheruvu, chief investment officer (CIO), WGC Wealth. Expensive valuations could also lead to a correction. Cheruvu expects the markets to rally next from mid-June in the runup to the Union Budget.

While the longer-term prospects of the Indian equity markets remain positive—Morgan Stanley expects the Sensex to touch 45,000 by June 2020, up 15 per cent from its current levels—one can expect the fundamentals to assert themselves soon. “The bullishness will continue only if it is backed by revival in earnings growth,” says Sampath Reddy, CIO, Bajaj Allianz Life Insurance. Adds Karthikraj Lakshmanan, senior fund manager–equities, BNP Paribas Mutual Fund: “From a three-five year time horizon, the markets could benefit from the pick-up in earnings growth even after budgeting for some normalisation in valuations.”

Policy continuity: With the same dispensation returning to power, one can expect it to get down to the task of dealing with problems, such as the economic slowdown and the non-banking financial companies (NBFC) crisis, faster. Earnings recovery, though not broad-based, has been witnessed in select stocks. “Over the past year and a half, banks have recognised their non-performing assets (NPAs) and cleaned up their books to a large extent. As credit growth picks up, we expect earnings of banking and financial services, which has over 35 per cent weight in the Nifty, to recover sharply from a low base,” says Vaibhav Sanghavi, co-chief executive officer, Avendus Capital Alternate Strategies. Reddy expects the slowdown in the consumption space to be temporary.

Globally, with economic growth remaining weak, central banks are expected to keep interest rates low and liquidity ample. Such conditions are positive for risky assets like equities.

The Reserve Bank of India (RBI) too can be expected to chip in to deal with current issues. “We expect rate cuts of 50-75 basis points in the current financial year,” says Garima Kapoor, economist, Elara Capital. She adds that steps by the RBI to infuse liquidity into the markets, such as open market operations (OMOs), forex swap, or cash reserve ratio (CRR) cuts, are also needed. Measures like opening up of a liquidity window for NBFCs and bank recapitalisation would also help address the dislocation in the financial sector. Quick transfer of cash benefits will also provide temporary relief to those in rural areas facing distress, and could help jumpstart consumption.

Several headwinds: Experts warn that the markets will have to negotiate several hurdles to be able to make a decisive upward move. The much-awaited earnings recovery has not yet materialised. Consumption slowed about nine months ago while the economy as a whole turned sluggish about three months earlier. The rural segment has been in distress for a couple of years now owing to low realisations by farmers on their output.

The monsoon should be closely watched as it will have a bearing on rural income and revival of consumption.

Globally, the US-China trade war continues unabated. The Brexit issue too has the potential to cause disruption within the European Union. Crude prices remain elevated despite slowing global growth due to the Iran sanctions and heated exchanges between US and Iran over the nuclear issue. “If any of these issues flares up, it would have the potential create a risk-off environment, which would affect investments by foreign institutional investors (FIIs) into emerging markets, including India,” says Kapoor.  

Mistakes to avoid: In a market that will be driven primarily by earnings recovery, investors should avoid a top-down investment approach. “Adopt a bottom-up stock picking approach. Go for stocks that display strong earnings momentum and are also attractively valued,” says Cheruvu.

Prudent investors should also avoid concentration risk in their portfolios. First, decide on your allocation to equities based on your risk appetite, then build a diversified portfolio. Avoid going overboard on a particular sector or stock even if you like it very much.

Avoid trying to time your entry and exit from the markets as doing so consistently over the long-term is a near-impossible task. A more prudent approach is to invest systematically (a limited amount every month) so as to average out your entry cost in the stocks you like. Having a short-term orientation can also prove costly. Experts say that most direct investors lose money because they trade in and out of stocks. With a long-term horizon of at least three-five years, they say, it is difficult to lose money in stocks in a growing economy like India, provided you pick your stocks carefully.

With select large-caps having run up and mid- and small-caps having corrected over the past year, do not make the mistake of shunning the latter completely, despite the pain you may have witnessed in these stocks in 2018.

Returns after election result (%)
Lok Sabha election		Index level		1-day		1-week		1-month
Year	Result date	Sensex	Nifty50	Sensex	Nifty50	Sensex	Nifty50	Sensex	Nifty50
2004	May 13, 2004	5,399	1,718	-6.1	-7.9	-8.7	-10.1	-12.1	-13.7
2009	May 16, 2009	12,173	3,672	17.3	17.7	14.1	15.4	22.2	22.1
2014	May 16, 2014*	24,122	7,203	1.0	0.8	2.4	2.3	4.4	4.6
*For 2009 election result date was taken to be May 15, 2009 as May 16, 2009 was a non-trading day (Saturday); Compiled by BS Research Bureau