It isn’t unusual for Indian equities to rally in the run-up to general elections. However, this time it is different.
The MSCI India Index is trading at a one-year forward price-to-earnings multiple of over 18 times. This is about 34% higher than the average valuation recorded one month ahead of the previous six general elections. India also remains a far dearer bet compared to its emerging market peers.
Now that the market has risen too far too soon and valuations are sky-high, this pre-election rally may well have limited legs.
“After the recent up move, the Nifty trades at about 18 times one-year forward earnings and at about 2.6 times price-to-book, which are about a standard deviation above their historical averages. Peer markets in Asia and elsewhere are closer to their historical averages. Thus, the relative valuation comfort we had at the start of the year is not quite there anymore," said Abhiram Eleswarapu, head of India equity research at BNP Paribas.
The rally has been driven by the strong return of foreign portfolio investors (FPIs). This has partly to do with increased expectations of a return of the incumbent, while another large part is the dovish stance taken by the US Federal Reserve. So far this year, FPIs have parked $6.3 billion in Indian stocks, after being net sellers of stocks worth $4.6 billion in 2018.
“Of these flows, most are exchange traded fund flows, which is passive money, easy money. So, these inflows may recede if the outcome of the general elections is not as strong as is being anticipated," said Jinesh Gopani, head (equities) at Axis AMC.
It’s also important to note that elections matter to the market only in the near term and fundamentals would take a front seat eventually.
“In the near-term, it wouldn’t be surprising if FPI flows took a breather as investors evaluate the fundamentals a little deeper," said Eleswarapu.
Meanwhile, the enthusiasm among technical traders continues but one should tread with caution. “The rollover cost in the March derivatives expiry cycle has doubled, indicating investors are carrying forward their long positions aggressively to the April series," said Chandan Taparia, derivative analyst at Motilal Oswal Securities Ltd.
But for this rally to meaningfully extend, fundamentals have to match valuations. “Currently liquidity is driving the market but there will come a tipping point when investors will have to look at earnings growth. Earnings have to catch-up. We expect March quarter earnings to be disappointing given the signs of weak consumption demand," said Dhananjay Sinha, head of research (institutional equities) at Emkay Global Financial Services Ltd.