A bumpy ride ahead for the Indian stock market
Any indication of political momentum shifting away from the ruling party will affect sentiment in the market
After rising about 1% in the intraday trade, as votes were being counted in Karnataka, the benchmark S&P BSE Sensex ended the day in the red after it became clear that the Bharatiya Janata Party (BJP) would not be able to cross the halfway mark to attain a simple majority. Clearly, the stock market was focusing on what the Karnataka results mean for the Lok Sabha election in 2019.
The base case for the market is that the Narendra Modi-led National Democratic Alliance government will be voted back to power in 2019. However, there is still about a year to go before the next general election and a lot can happen on the political front during this period. A post-poll alliance between the Congress and Janata Dal (Secular) could be a major step forward in attaining opposition unity. Similar alliances in large states, like Uttar Pradesh, could affect the BJP’s prospects in 2019. The stock market will closely watch the political situation as it unfolds. The next big test for the BJP will be assembly elections in states like Rajasthan, Madhya Pradesh and Chhattisgarh. Any indication of the political momentum shifting away from the ruling party will affect sentiment in the market. Investors like political stability and chances of uncertainty will not bode well for the market.
However, politics is not the only concern for the stock market at this stage. Plenty of issues, emerging on the economic front, will weigh on investors’ minds, and can potentially affect economic and earnings growth. For instance, crude prices have climbed about 20% since the beginning of the year and are up about 50%, year-on-year. They are expected to remain firm in the foreseeable future. Higher crude prices affect actual disposal income, push inflation, interest rates, and the current account deficit. All this will have negative implications for the stock market.
Further, the cost of money in the Indian economy is going up. The yield on 10-year government bonds touched a three-year high last week and is hovering around the 8% mark.
Aside from commodity price pressure, interest rates can go up further if the government decides to boost spending in the run-up to the assembly and Lok Sabha elections. This will not only increase the supply of government bonds but also force the rate-setting committee of the Reserve Bank of India to raise rates to contain inflationary expectations. A rise in borrowing costs will increase the interest outgo for the corporate sector and affect profitability. The higher risk-free rate will also push savings into fixed income instruments and compress valuations in the stock market.
The rupee is also under pressure owing to factors such as the possibility of a faster than expected rise in US interest rates, which is pushing up the dollar index, and a widening current account deficit. In the stock market, a falling rupee affects dollar returns for foreign investors. Therefore, a sharp depreciation in the rupee could increase the selling pressure from foreign investors. They have sold stocks worth over Rs2,700 crore in May so far, after offloading shares worth Rs6,209 crore in April.
To be sure, there are also factors that will support the market. Domestic institutional investors have become big buyers, thanks to the greater adoption of the systematic investment plans of mutual funds by retail investors. The domestic institutional investors, for instance, have bought stocks worth over Rs40,000 crore so far this year. Sustained buying by domestic institutional investors is likely to support the market. Also, the ongoing cyclical recovery in the Indian economy should help corporate earnings in the short to medium term. An early review of March-quarter results, published in Mint, showed that profits for BSE 100 companies accelerated at the fastest pace in six quarters and registered a growth of 12.13%, compared to 9.32% in the December quarter (bit.ly/2r8Q7o2). Consumption demand is showing signs of strength, which should help consumer companies. Auto sales went up by 12% in April, and, according to Crisil Ratings, revenue growth for fast-moving consumer goods companies is likely to expand by 300-400 basis points in the current financial year.
However, the stock market discounts the future in advance and the earnings recovery is partly built into stock prices. Going forward, unfavourable developments on the macroeconomic front will be a big risk for the market. It can affect market sentiment, earnings recovery, and compress valuations. Investors would do well to brace themselves for an increase in volatility in coming months.
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