Lok Sabha elections 2024 trading strategy: Poll-driven equity weakness buying opportunity, says UBS

Based on opinion polls, the market expects the National Democratic Alliance (NDA) to secure a third term in office, with a high probability of the BJP maintaining its single-party majority. This anticipated political stability is expected to ensure policy continuity, thereby supporting market sentiment and India's valuation premium.

However, any unexpected results could trigger knee-jerk reactions in financial markets in the near term, according to a report by UBS. 

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The opinion polls before the elections suggested further seat gains for the BJP Nevertheless, actual progress in the first five phases of the election has been less clear. Lower voter participation and the potential loss of some voter share in key states like Maharashtra, West Bengal, Karnataka, and Bihar due to regional political uncertainty have raised questions about the NDA's ability to secure a third term, noted UBS.

UBS highlighted that although the link between voter turnout and election outcomes is not straightforward, the drop in voter turnout has introduced an element of uncertainty that has reverberated through financial markets.

Despite the potential for near-term election-driven uncertainty, UBS reiterates its view that any sharp weakness in equities could offer buying opportunities. Within fixed income, it believes medium- to long-duration bonds are in a sweet spot and could turn more attractive if bond yields spike.

Election scenarios and market implications

Recognising the significance of this event for Indian financial markets, UBS has analysed four different election scenarios and outlined the potential impact on markets for each scenario.

Scenario 1: Based on opinion polls, UBS expects the BJP will retain a single-party majority. In this scenario, markets are likely to remain confident about policy continuity. 

However, the likelihood of further reforms, including disinvestment, the land bill, and the uniform civil code, could depend on the number of seats won. Overall, the financial market sentiment is expected to remain positive, it said. 

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Scenario 2: UBS assumes that if the BJP fails to retain its single-party majority, it will form a government with the NDA, achieving a majority (> 272 seats). In this case, markets could be slightly less confident about policy stability, as fiscal consolidation might proceed more slowly than expected. 

There could be pressure from other political alliances, but overall macro-stability could still persist. UBS expects a mixed impact on financial markets in this scenario.

Scenario 3: UBS envisions a hung parliament if the NDA fails to secure a majority (< 272 seats). This scenario, according to the UBS, could lead to higher market uncertainty with the potential for prolonged political negotiations. 

A less decisive government might result in delays in implementing reforms, increasing the risk of policy paralysis and negatively impacting financial markets.

Also Read: Market may see sharp 20% decline if election results deviate from expectations

Scenario 4: UBS assumes a change in government with the newly formed coalition, INDIA, securing a majority (> 272 seats). This scenario could bring significant market uncertainty with the potential for abrupt policy changes. 

UBS sees a high risk of reversing some reforms implemented by the NDA, potentially causing a sharp knee-jerk reaction in financial markets due to the uncertainty accompanying a change in government.

Market optimism hinges on BJP's majority retention

According to the UBS, markets are likely pricing in scenario 1 as the most likely outcome. If the election plays out as expected, it anticipates policy continuity, macroeconomic stability, and the potential for further structural reforms, all of which could positively influence Indian financial markets. 

Any unexpected outcome will likely be perceived negatively, at least at first, due to political instability and possible policy paralysis weighing on business sentiment and impacting investor confidence. 

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The brokerage said that this event could trigger knee-jerk reactions in financial markets in the near term, with equity valuations possibly testing pre-NDA levels.

BJP victory is expected to favor utilities, defence, cement, and real estate

From a sector perspective, a strong BJP mandate would imply an increased focus on infrastructure spending that would be beneficial for infrastructure-linked sectors such as industrials, capital goods, utilities, defence, cement, and real estate. 

Also Read: PM Modi shares rationale behind NDA's 400-paar and BJP's 370 seats target

On the flip side, UBS noted that a weaker BJP mandate leads to more spending on consumption and low-income households, which broader markets may not like, though it could help consumption-led sectors perform relatively well.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.