Taking stock of the market rally

It appears that the markets had some inkling about the results of the exit polls. What else could explain the 5.4% jump in the Sensex in two trading days after 40 days of somnolence when it inched up just 1.3%?

There was no economic data released until Monday evening’s consumer price index and industrial production numbers and no other emerging markets registered such gains. Till Thursday, India was lagging the so-called fragile five economies (the other four high current account deficit-susceptible nations being Indonesia, Turkey, South Africa and Brazil) in year-to-date returns. After Monday’s closing, only Indonesia is ahead, with Turkey neck-and-neck with India on stock market returns.

Thus the sharp jump in the previous two trading days boils down to foreign institutional investors’ (FIIs’) belief that a stable government will take charge before the end of the month. Securities and Exchange Board of India data show that FIIs bought $210 million of stocks on Friday and NSE provisional data, $200 million on Monday.

The key question now is whether this lowers the scope for a post-election rally. A comparison with the last election may help. The one-year forward price-earnings multiple for the Sensex on counting day in May 2009 was 14.5 times, according to Bloomberg data. The yardstick stood at 14.9 times on Monday.

Secondly, the performance of the equity markets during the 2009 Lok Sabha elections also suggests there is some juice still left in the rally. Then, not only did the Sensex rise 26% in 60 trading sessions leading up to counting day, it also rose 27% in the month after election results were declared.

Even if the markets were to gain half as much as they did then, that is still another 13% increase from the current levels. However, the caveat here is that while some conditions are the same as in 2009, like the economic slowdown, others are a lot different.

In 2009, the economy and the markets were boosted by a massive fiscal and monetary stimulus. Now, not only does the new government not have any headroom to provide a fiscal stimulus, a high consumer price inflation number will keep lending rates elevated for a longer time.

The good news, however, is that the world economy is in much better shape this time. In 2009, the world economic output shrank by 0.6% while the International Monetary Fund forecasts it to grow 3.6% in 2014 and 3.9% in 2015. That provides a base for exports-led growth this year.

In any case, analysts such as Ambit’s Saurabh Mukherjeabelieve that the elections are just an excuse for FII buying. They say that this buying is an instance of FIIs rebalancing away from other economies as the Indian economy recovers.