A weaker Modi government will give enough stability to support the economy in the near term ?

Market Strategy After the Surprise Verdict

The recent national elections in India delivered a surprising verdict. The BJP-led NDA coalition narrowly secured victory with 292 out of 543 Lok Sabha seats, significantly below the exit polls' average of 369 seats and the BJP's ambitious target of over 400. This unexpected outcome suggests a weakened sentiment among lower-income demographics, leading to a negative market reaction. The Nifty index has given up its gains from the past month, reflecting the market's initial confidence in a BJP majority.

Market Reaction and Sector Performance

Over the past decade, the BJP government has maintained a strong focus on development, supported by substantial infrastructure investments. Despite the weaker-than-expected mandate, we believe the continuity of power will provide enough stability to support the economy in the near term. However, sectors closely tied to the 'Modi' narrative, particularly Defence, have experienced significant corrections. Stocks such as Bharat Dynamics, Hindustan Aeronautics, and Bharat Electronics have seen sharp declines. Additionally, the Power and Railways sectors have also faced substantial cuts.

Despite these setbacks, we remain optimistic about the government's ongoing commitment to these sectors. The 'Make in India' initiative, particularly for defence manufacturing, is expected to continue, with the government planning to execute USD 43 billion in Indian-made products during FY24. Furthermore, power demand in India has historically grown at 0.8-1x of real GDP growth over the past two decades, and emerging use cases like electric vehicles and data centers are likely to sustain this demand.

Economic Outlook and Key Indicators

India's economic momentum remains robust, with an anticipated 8.2% real GDP growth for FY24, marking the ninth time since 1961-62 that GDP growth has surpassed the 8% threshold. The Indian Meteorological Department (IMD) forecasts an above-normal monsoon, which, along with easing raw material pressures, should support corporate margins.

Historically, the Nifty index has performed positively in the months following general elections. Since 1991, the index has posted average gains of 9% and 8% over the three and six months post-elections, respectively, indicating that election-related market corrections often turn into long-term buying opportunities. Currently, the Nifty is trading at a one-year forward price-to-earnings (PE) ratio of 20x.

Prime Minister Modi's post-election address exuded confidence in policy continuity and a commitment to fulfilling the party's manifesto. The government is expected to maintain its focus on key areas such as affordable healthcare, housing, energy transition, infrastructure development, and manufacturing, including semiconductor and infrastructure projects.

Key Events to Watch

As we move forward, several key events will shape the market outlook:

1. Government and Cabinet Formation: The composition of the new government and its cabinet will provide insights into policy direction.
2. Monetary Policy Committee (MPC) Meeting: Scheduled for June 7, 2024, the MPC's decisions will impact monetary policy and market sentiment.
3. Onset of the Monsoon: The timing and distribution of the monsoon will affect agricultural output and rural consumption.
4. India Budget: The upcoming budget will outline the government's fiscal priorities and spending plans.
5. Q1FY25 Earnings Season: Corporate earnings will provide a gauge of economic health and business performance.
6. Inclusion in JPM-GBI: India's potential inclusion in the JP Morgan Government Bond Index (GBI) could attract foreign investment.
7. State Assembly Elections: Upcoming elections in Maharashtra, Haryana, and Jharkhand will be critical for gauging political sentiment.

Investment Strategy

Despite the current market volatility, we maintain our Nifty target at 23,500-24,000. We anticipate continued economic growth but recognize the potential for peaking earnings growth and rich valuations in certain sectors. Our strategy emphasizes an overweight position in financials, while maintaining selective picks across other sectors.

We recommend assigning more weight to large-cap stocks due to their stability and resilience, while being highly selective with mid-cap and small-cap stocks. In the short term, we view the recent market sell-off as somewhat extreme, potentially paving the way for a rebound, particularly for capex-linked stocks.

Conclusion

In conclusion, while the narrow election victory has introduced some uncertainty, the underlying economic fundamentals remain strong. The government’s focus on key sectors and development initiatives, coupled with historical market resilience post-elections, suggests potential for growth and recovery. Investors should stay informed, strategic, and ready to capitalize on emerging opportunities in this dynamic market environment.