What will be the likely impact of the election results on the stock market?
If a coalition with either of the two big parties—the Congress or the Bharatiya Janata Party (BJP)—at its core is able to form the government, the market should feel reassured. Whether it’s the BJP or the Congress is unlikely to matter, although brokers are talking of an upside for the rural story should the Congress-led United Progressive Alliance (UPA) form the government and for infrastructure (a la the Golden Quadrilateral) if the BJP-led National Democratic Alliance (NDA) takes over.
What if the Third Front is able to cobble together a ruling coalition? Well, the market is worried about instability, rather than ideology, which is why both a UPA and an NDA government will be seen to be positive. The problem with the Third Front, say market participants, is that it’ll be very unstable and the ruling parties may, therefore, go in for populist measures, such as raising taxes for the rich, increasing capital gains tax and giveaways for the masses. It’s a bit unfair, though, to brand the Third Front as populist when the BJP manifesto promises a waiver of farm loans and both the Congress and the BJP promise cheap rice. And as for raising taxes or increasing the size of the fiscal deficit, look what’s happening in the UK and the US. Also, even a Congress- or BJP-led coalition with volatile partners such as Jayalalithaa or Mayawati may not be very stable.
Nevertheless, a Third Front government is likely to make the market very jittery.
But while the market may go down immediately if the government is unstable, won’t that fall be short-lived? After all, in 2004 the markets were frozen at the lower circuit after it became clear that a UPA government with the support of the Left was going to form the government. Analysts point out, though, that things are very different this time. In 2004, the stock market boom was just getting under way while this time the markets are deep in distress.
The simple truth is that global factors matter far more for Indian stock markets.
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So, if global markets improve and risk appetite comes back, our markets should continue to do well. What might happen, though, is that Indian equities will underperform other markets if we have an unstable government, while we could continue to outperform other countries if a stable government comes to power. In other words, even the bears seem to agree that if the markets improve globally, markets in India will follow suit, regardless of the kind of government we have, although we will underperform other markets if we have an unstable government.
The key question, then, is whether the current global rally is sustainable.
One way to consider that is to think of what it means if this is the beginning of a bull rally. If it is, it will mean that the trillions of dollars of wealth that have been lost as a result of the collapse of the “shadow banking system” have somehow been restored and that business will very soon go back to where it was before the meltdown. It will mean that all the talk about comparing the current crisis with the Great Depression was so much hogwash. It will mean that the world will go back to a situation where leverage is very high and the debt-ridden US consumer continues to hold up the world economy and all the angst about global imbalances is completely misplaced. It will mean that all the studies of financial crises carried out by researchers such as Reinhart and Rogoff and the International Monetary Fund, which say that the crisis lasts years and recovery is very slow, are plainly wrong. The odds of all this are extremely low, which is why the current rally is a bear market one. The head of an FII fund points out that the quality of the rally is suspect and it is fuelled by hot money flows.
As David Rosenberg, till recently an economist with Merrill Lynch, pointed out, “It is clear that we are beyond a garden-variety recession. Even after nearly a year and a half of unprecedented interest rate relief, multiple liquidity backstops, banking sector capital injections, loan modifications and record tax rebates, there is still no end in sight for the contraction in credit, bear market in financial stocks, decline in real economic activity, peaking unemployment, or any signs of normalcy returning to credit.”
But if fixing the global economy will take time and if the rally is a bear market one, what’s the likely trajectory of the recovery? Writes Jeremy Grantham, chairman of privately held global investment firm GMO Llc., and investment guru, in his latest quarterly newsletter: “So we’re used to the idea of a preferred V recovery and the dreaded L-shaped recovery that we associate with Japan. We’re also familiar with a U-shaped recovery, and even a double-dip like 1980 and 1982, the W recovery. Well, what I’m proposing could be known as a VL recovery (or very long), in which the stimulus causes a fairly quick, but superficial recovery, followed by a second decline, followed in turn by a long, drawn-out period of sub-normal growth as the basic underlying economic and financial problems are corrected.”
In India, the worst may be behind us, but the recovery is still very feeble. If Grantham is right, even a strong, stable government in India will not do much for the market.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org