The Indian stock markets are experiencing notable turbulence as the country gears up for its General Elections. What has added more to the chaos is that Foreign Institutional Investors (FIIs) have pulled out in record numbers, causing significant concern among market participants.

Historically, Indian stock markets have generally performed well during election periods, except for the 2004 elections, when the markets were adversely affected by the Iraq war; the benchmark indices have typically seen positive returns in the months leading up to the polls.

However, this year, market participants are unusually nervous.

The Bear Running Amock

Both the Sensex and Nifty indices have shown minimal growth, rising just 2.4% and 3.5%, respectively, until the past weekend, representing the worst performance since the 2004 elections. 

Additionally, the India VIX, a measure of expected market volatility over the next 30 days, has surged by 40% to 20.5, indicating heightened nervousness among investors.

To provide context, since 1996, the Indian stock indices have often delivered double-digit returns during the January to mid-May period. There have been four instances of double-digit returns and three instances of single-digit returns. The exception was in 2004, when the indices fell by 16%.

Pramod Gubbi, founder of Marcellus Investment Managers, noted that the current election period follows a bumper year for the markets, which is unlike the previous three election years that followed relatively weak market periods. 

This historical context may explain why the markets are not performing as robustly this time.

Also, there are several factors that are contributing to the market’s unease. 

At the start of the year, market bulls were confident that the incumbent government would secure a strong mandate in the Lok Sabha elections and that the US Federal Reserve would begin lowering lending rates. 

However, these expectations have not materialized. 

What is Weighing Market Sentiment?

And now, there is uncertainty regarding the number of seats the incumbent government will secure, and the Federal Reserve has delayed any rate cuts.

Likewise, geopolitical tensions in the Middle East and China’s resurgence as an attractive investment destination are weighing on market sentiment. 

These factors, coupled with the high valuations of the Indian market compared to global standards, have prompted investors, particularly FIIs, to withdraw their investments.

Given the Indian market’s valuations, which are among the highest globally, investors, particularly foreign institutional investors (FIIs), have decided to withdraw some of their investments.

FIIs have net sold shares worth around Rs 28,500 crore so far in May, making it one of the worst months in recent years from a foreign fund flows perspective.

The Glimmer Of Hope

Despite these concerns, Andrew Holland, CEO of Avendus Capital, still sees the potential for 12-15% returns from benchmark indices this year. 

Others also believe that while there are challenges, it does not necessarily mean the markets will have a bad year.

If interest rates remain at current levels for most of the year, experts believe Indian equities may not be as attractive to FIIs given the high valuations. 

However, if the domestic economy stays strong, private capital expenditure accelerates, and earnings growth shows strength, these factors could encourage FIIs to return to the Indian market.

What Is Important For Indian Stock Markets?

Experts believe that earnings growth will be a crucial factor in determining the market’s trajectory going forward. 

The March earnings season has so far met expectations, but many analysts argue that the earnings do not justify the “extraordinary” valuations.

“For the IT sector, the worst doesn’t seem to be over. The Federal Reserve’s stance on keeping rates higher for longer means there is no significant tailwind for the IT sector,” said Andrew Holland, CEO of Avendus.

Holland added that while the worst might be over for banks in terms of net interest margins (NIMs), sentiment has been negatively impacted by regulatory actions on Kotak Mahindra Bank and proposed norms on project financing.

Modi’s Confidence in Market Surge on June 4

Meanwhile, as Phase 5 of the Lok Sabha elections gets underway, Prime Minister Narendra Modi, in an interview with a TV channel, downplayed the nervousness on Dalal Street regarding the poll outcome. He confidently stated that Indian stock markets will break all previous records on June 4.

“You see, the day election results come out, and throughout that week, stock market programmers will get tired of the action,” Modi said to a media channel. 

He further spotlights the market’s growth over the past decade, rising from 25,000 to 75,000. 

“The more common people invest in stock markets, the better for the economy. And the risk appetite of every citizen should rise,” he said, pointing to the rally in public-sector firms as evidence of the Centre’s economic reforms and pro-entrepreneurship policies.

Modi’s statement follows an assurance by Union Home Minister Amit Shah to stock investors, advising them “to buy before June 4.”

The General Direction

Nomura India, referencing recent opinion polls, suggests a BJP win and policy continuity post-2024 general elections. Their outlook includes a sustained focus on infrastructure spending, a manufacturing push, and fiscal consolidation.

“The government may focus on the more politically contentious reforms around the factors of production, including land, labour, and capital; judicial reforms; and simplifying direct and indirect tax administration, including bringing electricity, oil and gas, and alcohol under the GST ambit. The government is also likely to further focus on improving the ease of doing business for foreign investment and laying the groundwork for next-generation sectors,” Nomura said.

Conversely, MUFG Bank noted that while there is an overwhelming consensus among political observers and polls about a likely strong win by the incumbent BJP government, there could be modest knee-jerk weakness in INR FX and risk assets if the BJP loses some seats but maintains a majority.

“As long as BJP wins a majority of seats in the Lok Sabha again (>272 seats), we think markets should still view the outcome of India’s General Elections positively over time. Conversely, a greater seat share win by the BJP compared with 2019 (>303 seats) would increase the ability to pass more contentious structural reforms in land, labour, and the agriculture sector, and will be perceived much more positively by markets, with INR FX and risk assets likely rallying in the aftermath,” MUFG stated.

Mirae Asset stated that should the BJP secure victory, the focus will shift to the July Budget, with particular attention on potential alterations in direct or indirect taxation, MSP policy, and MGNREGA payments. In the longer term, emphasis will be placed on infrastructure development, farm laws, skill enhancement, and job creation in manufacturing, aiming to stimulate demand from rural India, according to Mirae Asset Capital Markets.

PhillipCapital recently expressed its anticipation of a robust market rally if the BJP-led NDA achieves its highly publicized target of 400 or more seats. Should the NDA secure a lower range of 300-330 seats, resulting in a short-term market dip, PhillipCapital views this as a buying opportunity. 

The brokerage emphasized the importance of monitoring voter turnout in subsequent election phases, noting its potential impact on election outcomes and equity markets.

The Last Bit, Indian equities face a challenging year in 2024. 

A strong domestic economy may provide some cushion, but factors like earnings growth and private capital expenditure will need to accelerate to ensure a clear path to double-digit returns.

At the same time, all eyes are on the verdict that is to come on June 4. Will BJP’s Modi and Shah recreate the magic, and will the markets zoom, as Modi confidently stated? 

We shall see!