PRE ELECTION RALLY – HOW SHOULD ONE PLAY THIS THEME?

Looking at market trends currently it is no surprise that the pre election rally has started on a strong note. While nobody can correctly predict as to who will win the elections, a study of returns from the markets and stocks three months prior to the last five general Elections in India has shown that historically, prior to the elections the broad equity indexes have risen by 10-12% on an average

Barring 2004 which saw a flattish trend, markets have typically traded strongly in the run-up to the general elections. Interestingly, this outperformance was more pronounced prior to the 1999 and 2009 general elections where a particular party was expected to win by a majority.

The BJP this time appears the favorite to win this years general election especially following its rout of the ruling Congress party in a series of important state assembly polls.

The scale of the BJPs victory and the strong support shown for the anti-corruption AamAdmi Party (AAP) has highlighted widespread anger with the Congress-led government and indicates the likelihood of a change of government at the Centre.

Having said this, AAPs decision to contest the LokSabha polls presents a potential threat given their socially popular policies which can drain the economy. Investors love political certainty and change is always welcomed.

Since 1989, India has not seen a single party majority government. And there have been seven elections ever since. Equities performance in the short term is clearly linked to the election outcome and expectations about the same, as it is perceived to influence economic policy decisions.
The markets have rallied only close to 3% since the start of the year, and we are still more than two months away from the election results. There is a strong likelihood which is evident form the past elections of the markets rallying further in anticipation of a strong election verdict

Moreover, if the verdict does come in the form of a strong mandate, markets could rally even further in anticipation of policy reforms (as was seen in 1991 and 2009) In the event of a strong outcome (1991 & 2009), equities had rallied further (27.9% & 17.1%).

In the event of a weak outcome (1989,1996& 2004), equities had sold off (-0.9%, -3.6% & -9.3%). In the 1999 election, when the verdict was neither weak, nor strong, but just stable, markets did not react significantly

While elections would be the short term trigger for the markets we believe the impact of other factors, like global equity environment, global liquidity, etc cannot be ignored.

Besides, as election results are digested by the markets, underlying economic fundamentals of India will start to play out, as we do expect an improvement in the macroeconomic demand in the second half of the year, as policy becomes more clear after election results

However in case we have a strong coalition government from either the BJP or congress the markets would rally further with industrial and infrastructure likely to hog the limelight. Here it would be stocks like Larsen & Toubro, Crompton & Graves and Voltas which could see further upside. Also PSU Stocks within the Gas and fertliser space would attract buying like Oil India, ONGC and CoromendelFertlisers.

Financials are also expected to move further as this space would be the maximum beneficiary of policy reforms and rate cuts going ahead. Here ICICI Bank, Axis Bank, HDFC Bank, PNB and SBI would be clearly be in focus.

In the event the elections do not present a strong coalition then we believe that the markets would take a balanced view on the markets, more importantly the focus would return on defensive sectors like IT, Pharma and the FMCG sectors.

At Niveza Research we would like to play the Pre Election Rally on the following key stocks/sectors as we believe that retail investors could get good returns from these stocks as most of these companies have strong balance sheets and growing earnings triggers ahead.

Within the Capital Goods space we continue to be positive on Larsen & Toubro, while in the Auto space we like M & M and Tata Motors. Cement and Media are also sectors where we could see a big upside post elections. Especially TV companies and print media players would be big beneficiaries of increasing advertising spends in the pre election period. Here Zee Entertainment, HT Media, DB Corp and Ambuja Cements look attractive at current price levels.

Other stocks which come to our mind purely due to the close proximity of Modi towards large corporates includes names like Reliance Industries, Reliance Capital, Reliance Infra, Adani Ports, Adani Enterprises, Gujarat Pipavav, GSFC, GMDC, Sintex Industries, United Phosphorous, Atuland Arvind Limited.

Ultimately everything will converge in the medium term towards the macro improvements (inflation, interest rates) as we believe the economy is likely to see improvement in the second half of FY15.

The magnitude of improvement will however depend on the composition of the government, and that's why the eager await for the election results.