Is a Modi put propping up the Indian stock markets?
For a short while on Monday morning, it seemed as if the Congress party might leave the Bharatiya Janata Party (BJP) behind in the crucial Gujarat assembly election. The reaction in the stock market was swift and severe, with the Sensex plunging more than 800 points (or 1%) in early morning trade. As BJP’s leads rose, the 30-stock bellwether recovered in what appeared to be a relief rally. On Tuesday, the Sensex rose to a historic closing high of 33,836.7 points.
The market reaction on Monday was not an exception, an analysis of market movements during past election verdicts shows. On every day of a major state assembly election since 2014 (or the following day when the results were declared on a holiday), markets have cheered a BJP victory, and have sunk when its fortunes dipped.
The Sensex’s return on a market day has always been much higher than the median return over the past five trading days in the event of a BJP victory, and lower than the median return in the event of a BJP loss.
What explains the market’s love affair with BJP?
One explanation could be that investors repose immense faith in the party and its leader, Narendra Modi, and that they believe that Modi’s policies will drive growth and investor wealth. In fact, Saurabh Mukherjea of Ambit Capital, in a 9 November note, argued along these lines when he suggested that a “Modi put” was propping up Indian markets despite what he described as “surreal valuations”.
The “Modi put” is an Indian adaptation of the Greenspan put, so named after former US Fed chairman Alan Greenspan, who was believed to step in to ease liquidity whenever the markets crashed. A put option is an option contract which gives the owner the right, but not the obligation, to sell the specified security at a specified price.
Mukherjea argued that the government seems to have been sensitive to investor concerns, and when concerns about the growth slowdown were voiced over the past few quarters, the government has been proactive in taking corrective steps.
“The...pattern of events is leading investors to believe that there is a Modi put in play; i.e. when GDP growth slows down, the NDA will go into overdrive mode to reflate the economy,” wrote Mukherjea.
But an alternative explanation of the market’s gyrations during election verdicts is also possible. Given India’s history of weak coalition governments since the late 1980s, markets may simply be reposing faith in stability and continuity rather than reposing faith in a Modi put. It is worth noting that the love affair with Modi has not been unconditional. The day after demonetization was announced on the night of 8 November 2016, the market reaction was extremely negative, with the Sensex declining much more on 9 November than the median of the previous five trading days.
Also, a look back at a slightly longer stretch of history suggests that the market was very much enamoured with former Prime Minister Manmohan Singh as well, not too long ago. The return of Manmohan Singh as Prime Minister in 2009 saw the Sensex rising by a whopping 17% on the first trading day after the verdict.
To be sure, the initial market reaction to the first United Progressive Alliance (UPA) government under Manmohan Singh was not so positive. The market reaction was cautious when the Congress emerged as the single largest party, and the Sensex tanked 11% when it emerged that a Left-supported UPA alliance was going to take over the reins of power on 17 May 2004. That crash even prompted an investigation which led to penalties against a few institutional investors.
Nevertheless, five years down the line, markets were ready to believe that freed from the alliance with the Left parties, Singh would chart out a path of reform and growth that would multiply investor wealth.
In fact, on the first day of trading after the 2009 Lok Sabha verdict, trading on Indian bourses had to be halted as key benchmark indices hit the upper circuit.
Yet, that love affair soured over the next few years as hope turned to bitterness. Modi and his advisers would do well to keep that history in mind.
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