Dear All,
Why markets may see a sharp fall post May 16
Election results: Any election outcome other than the market expectations may lead to a sharp fall in the market. The rally is primarily driven on the hopes of exit polls. However, these polls have been misleading in the past two elections.
In 2004 general elections, all the exit polls predicted a return to power for the NDA, giving it 270 to 280 seats. The end result? The BJP-led alliance was routed by the UPA (218) and the NDA got just 181 seats.
In 2009 general elections, all the exit polls predicted a thin lead for the UPA (190-200 seats). The end result? The Congress-led UPA got 262 seats while the NDA was reduced to just 159, worse than those in 2004.
"We believe the market is currently pricing in a stable coalition. In case of a shock result, we see a steep correction in the market as hopes for an early revival in the economy are diminished. In the case of a fractured mandate, the markets could correct by 15-20% from the current levels," said a Bank of America Merrill Lynch report.
Delay in reforms: The BJP-led government will find it difficult to pass legislative reforms due to less numbers in Rajya Sabha. The BJP has 45 members in the upper house. It will take multiple years to change in composition.
"Legislative reform will be much harder to do because the BJP would not control the Rajya Sabha for a couple of years to things like labour reforms, changing the land acquisition act, tax reform etc. It will take a lot more time, perhaps one to two years. But talk about that will start quickly, and action will take a lot longer to push through.
The NDA coalition may have to seek support of regional parties such as Mamata Banerjee's Trinamool Congress (TMC) or Jayalalitha's AIADMK. However, the aggressive campaign by Narendra Modi against TMC, AIADMK and BSP might become a roadblock.
Earnings: While the markets have moved up in anticipation of a strong government, corporate earnings have not shown any considerable change. If the BJP government fails to improve the economic environment quickly, the market may give up the recent gains.
"Corporate India earnings have not turned around. They continue to remain weak and already a lot of expectations have been built up in the valuations. Our sense is over the next 9 to 12 months, earnings could be weak. If the government expectations do not come through, you could have a major crack in the market. If it comes through, the upside could be limited," said Nilesh Shetty, Associate Fund Manager (Equity), Quantum Asset Management Company.
"The earnings cycle continues to remain weak, but the stock price continues to rally and this is primarily flow-driven and expectations-driven. So there is a disconnect between what is happening in the stock markets and what is happening to the earning cycle of the companies and valuations are turning expensive for a lot of companies," he added
Weak IIP, high inflation: The market, at the moment, is discounting the weak IIP and high CPI inflation data. Industrial production contracted for the second month running in March while consumer inflation accelerated to a three-month high in April, summing up for the next government the challenge of reviving growth while reining in prices.
India's IIP in March contacted 0.5 per cent compared with a 1.8 per cent decline in February and the CPI showed consumer inflation accelerated to 8.59 per cent in April from 8.31 per cent in March.
"While the RBI's own trajectory for CPI does account for 8% plus CPI inflation till mid-2014, the momentum in food inflation, especially given the higher probability of an El Nino effect, will be a very important driver of headline CPI," said an Espirito Santo report.
"We expect the RBI to leave the repo rate unchanged in the monetary policy meet scheduled for 3rd June as the progress of El Nino and the fiscal policy of the new government become clearer," the report added.
Global factors: The continuing stand-off between Ukraine and Russia is giving jitters to global markets. On Tuesday, insurgents attacked trucks carrying Ukrainian soldiers in the eastern Donetsk region. At least six men were killed and eight were injured.
The Western countries had imposed sanctions on Russia after its troops had surrounded the Crimea region. A further escalation of tension between Ukraine-Russia is likely to push the crude oil prices higher and create volatility in the equities and commodities market.
The US Federal Reserve is expected to continue with tapering of bond purchase program and that could lead to volatility in the emerging market currencies
"It is clear from Fed Chair Yellen's statement that she is looking for a moderate pace of recovery in the US economy. This is in line with our own expectations. Clearly, the bar for discontinuing with a tapering of QE is quite high. So we are still expecting that there will be an end to tapering by October this year,"
However, the Reserve Bank of India and the Finance Ministry have been proactive and taken measures to tide over any such currency volatility in the future.
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It looks like nifty on a hurry with bull. Hope it completed sub wave (II) and may move up also. Provided the gap left on the downside should be watched. Lets See.
