Dalal Street waits for poll cues

The past few months have seen Indian markets on a roller-coaster ride, but with more lows than highs—a far cry from the blockbuster year that was 2017. A weakening rupee, rising crude oil prices, a fraud at Punjab National Bank, and tension over the global trade war between the U.S. and China caused sharp volatility in the stock market. The latest blow came in September when fears of a liquidity crunch stoked by a defaults crisis at IL&FS triggered mayhem. Although Dalal Street has seen a bit of a recovery from these jolts, the bulls still seem to be in no mood to make a comeback. So far, the market hasn’t moved much from the point it began this year. The benchmark BSE Sensex had gained nearly 1,600 points till mid-November this year, compared with over 6,500 points a year ago.

But global investment and research major Morgan Stanley, which entered India 25 years ago, remains hopeful on Indian markets. In the time it has been in the country, Morgan Stanley India says the country’s GDP has gone up 10-fold, stock market capitalisation is up 22-fold,the Sensex has been one of the best performing indices in the world, and the MSCI India dollar index has outperformed the MSCI Emerging Markets dollar index by around 75 percentage points. Therefore, it has been a good two-and-a-half decades for the Indian markets and the economy.

Ridham Desai, managing director of Morgan Stanley India, calls the most recent sell-off period “just a correction” and asserts there’s no panic. “A lot of things have happened globally; I think the markets have responded to that,” he says, adding that mid-caps were up 60% last year, so this is a “give back” of that.

A recent report by Morgan Stanley India sees India’s economy surpassing the $6 trillion-mark over the next decade; with per capita income touching $4,100, it will be an upper-middle-income country. The report also expects stock market capitalisation to reach $6 trillion by 2028.

Desai lists three broad “enabling factors”for good growth over the next 10 years: demographics, with India poised to become the world’s youngest nation soon; globalisation,with India becoming a bigger player in global trade; and reforms, like the Insolvency and Bankruptcy Code and the goods and services tax, which will help boost productivity.

Despite these long-term positives, the equity investor seems to be still waiting for a trigger to change market sentiment. What could that trigger be? According to Desai, it will be something one cannot foresee. “What will move the market is an ‘unknown’ unknown factor, like what we got in September with IL&FS unravelling. We got a squeeze in NBFC [non-banking financial company] liquidity and suddenly stocks were down. It wasn’t oil, it wasn’t currency. Oil was already rising, currency was already depreciating,” he says. He emphasised that what shook the markets towards the end of September was something one didn’t see coming and what will take the market up too will likely be something one cannot anticipate.

Desai goes on to say that the response from the central bank and the government in terms of addressing the liquidity crunch concerns in the NBFC space after the crisis at IL&FS was a strong one. “They have addressed the perception about liquidity very aggressively. There is a lot of money now sloshing about in the system waiting to be deployed. You can see that in the 10-year bond yields which have dropped 40 bps [basis points; one basis point is one hundredth of one percentage point] from the high they touched at the end of September,” Desai says,adding that the so-called liquidity crisis is behind us. “But I’m assuming that we will not get a big negative surprise in the elections and there won’t be any upheaval in global stocks;which I’m not too sure about because we’re not constructive on global stocks.”

Turning his attention to the impact of the upcoming general election on the stock markets, Desai says that Dalal Street has not priced in an election result yet as it is awaiting the results of the current assembly elections. “My view is the state elections do not have any bearing on the general election as state politics and central politics are different. But this view is not going to matter to the market. If the market sees polarisation, then the market will start believing that we will see a polarised result in 2019 and stocks will go up,” Desai says.

Historically, markets have always approached general elections with a sense of optimism,points out Desai. “The reason for that, I guess,is that in each of the previous elections since 1991, the market has had the possibility of a stronger government because we have only had coalition governments. But now we are heading into an election with a stronger government in power and the possibility of a coalition government. So the markets may not approach it with the same sense of optimism,” Desai cautions.

According to him, there are two main determinants when it comes to elections: One is the state of the growth cycle and the other is pre-poll alliances. Desai explains that growth tends to lead election results by 12-15 months. “So if growth is good, it favours the incumbent,” he says. On pre-poll alliances, he says pacts formed in Uttar Pradesh and Maharashtra—the two states account for 128 of the 543 Lok Sabha constituencies in the country—will be crucial. “In our view, the two states that are most material are Uttar Pradesh and Maharashtra. So any alliances in these states could be a major swing factor for the election results.”

Going forward, Desai says he expects a good performance from companies in the financials and consumption space—aided by the clean-up of non-performing assets or bad loans, reforms, and the rural demand growth story. He is also bullish on mid-caps and small-caps, which he thinks have been “thrashed badly and now valuations look reasonable”.

For the household retail investor, Desai says a systematic investment plan is the way to go as it takes care of market cycles. “Household investors have responded extremely well to this correction. Their response suggests that they are here to stay,” he says.

(This story was originally published in the December 2018 issue of the magazine.)