The Stock Market & General Elections

Ambit Capital has come out with a research note tilted Invest into India’s ‘Fourth Wave’. Below is a brief extract.

Over the last 30 years, India has seen three waves in its politics, its economy and its stock market. Each wave has begun with a political reset wherein a new party or coalition has come to power with a fresh economic ideology which in turn has helped lift the economy and the stock market.

Now, with opinion polls pointing to an NDA coalition winning the most seats in the coming General Elections, India stands on the cusp of its ‘Fourth Wave’. With 7 out of the past 8 General elections being followed by strongly positive stock market returns (with an average Sensex return of 27% per annum in the 2-year period following elections), there is a strong case for investing into India’s Fourth Wave.

Wave 1 (FY 1985-92)

The first sine wave of economic growth was catalysed by the Congress’s landslide victory in the 1984 elections. The economic reforms which Indira Gandhi had already kicked-off prior to her assassination combined with incremental reforms under the new prime minister Rajiv Gandhi, gave India its first growth boom and a strong stock market rally.

• Stock market return on a CAGR basis: 43%
• Sensex churn: 13%
• Winning sectors: Consumer Durables, Capital Goods

Wave 2 (FY 1993-03)

The second sine wave of economic growth was catalysed by the formation of a Congress-led minority government headed by prime minister PV Narasimha Rao in 1991. The formation of this government combined with the tailwind of economic reforms administered in CY91 led to the second sine wave of economic growth in India accompanied by the early 1990s’ scam-riddled stockmarket boom.

• Stock market return on a CAGR basis: 3%
• Sensex churn: 63%
• Winning sectors: Refineries, Information Technology

Wave 3 (FY 2004-14)

The third sine wave of economic growth was catalysed by the formation of the UPA government in the 2004 General Elections. The formation of a government with a clear majority combined with the tailwind of reforms administered by the NDA led to the materialisation of India’s biggest economic boom alongside an exuberant stock market.

• Stock market return on a CAGR basis: 14%
• Sensex churn: 50%
• Winning sectors: Banks & Financial Institutions, Metals & Mining

Wave 4

India is on the cusp of its fourth wave, a wave which is being triggered by a politics and policy reset. The political reset is likely to bring the central issues of economic management and transparency at the forefront of the 2014 election.

On the economic front, Narendra Modi’s potential ascension to prime minister is likely to result in a renewed focus on a revival of the beleaguered infrastructure and banking sectors, on labour reform and agricultural reform, and on privatisation.

A Modi-led government is also likely to roll back the UPA’s extensive social welfare policies. This policy reset has significant investment implications.

These implications can be best understood through three types of investment strategies:

 (1) Invest in good and clean stocks

The most straightforward way to profit from the emerging political construct (wherein the politically connected companies are coming under pressure) is to focus on well managed companies with relatively clean accounts and credible corporate governance. This philosophy has been at the heart of our ‘Good & Clean’ (G&C) portfolios over the last three years. Not only have these portfolios outperformed the BSE500 by 18 percentage points since March 2011, we believe this philosophy will continue to generate strong results going forward.

(2) Invest in pure plays on our three megathemes

Whilst G&C is a more tactical portfolio, a more fundamental way to profit from the major resets that we are heading for would be to focus on long-term plays on the three megathemes that we have highlighted over the past year: Industrial exports, mass scale aspirational consumption, and turnaround plays in light industrial manufacturing.

(3)Invest in companies which are at the intersection of the three megathemes

Over the past decade, consumption and investment in India have never moved in sync with each other and this has created macro imbalances.

The NDA’s policies have the potential to allow consumption and investment to grow in sync. For example, if the NDA is able to push through reforms in the agricultural sector, not only can this dampen food inflation, which has risen steadily over the past six years, but also lift farmers’ incomes (remember, the APMC Acts currently enrich the middlemen at the expense of the farmers) and thus stimulate rural aspirational consumption.

Such policies creates a new set of investment opportunities focused on companies which are at the intersection of our three megathemes.