Will a Modi Victory Pave the Way for the Next Bull Market? - The 5 Minute WrapUp by Equitymaster
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Will a Modi Victory Pave the Way for the Next Bull Market?

Mar 11, 2019

Ankit Shah, Research analyst

A family friend called me last evening after the Lok Sabha election schedule was revealed.

He sounded quite jovial. We talked about politics and upcoming elections. And then, we got talking about the markets.

A few minutes into the conversation, my friend shared his market outlook for 2019...

'I think the bull run is back. The Indo-Pak border tensions have subsided. The prospects of another Modi victory in the 2019 Lok Sabha elections are strong. Small-caps and mid-caps are rallying again, after a deep correction. I think it's a good time to go for a big round of stock buying. What do you think?'

Do you find yourself thinking like this gentleman? If not the same theory, maybe a different story?

It's a difficult urge to resist. We open the newspapers (or our smartphones). We look at the television headlines. We talk to a few friends and acquaintances. And lo, we have a perfect-sounding theory on everything, including what "really" happened in the recent face-off between India and Pakistan, who will "really" win the general elections, and where the markets will "really" go in the near future.

Often, we like to believe that we're the only ones who're able to see the big picture. The truth is that we are all constantly trying to build a narrative of what's going on around us and in the markets. Most of the times, we end up adopting theories and predictions that fit our predispositions.

But can we really know it all...the reality of what's really, really going on in the markets?

In my view, it's impossible.

You see, the economy and the stock markets are highly complex, dynamic systems. There are so many interconnected, changing variables that can alter the future course of events.

Does a Modi victory necessarily mean the bull market will resume?

  • Maybe Modi wins and the bull market resumes.
  • Maybe Modi wins and the markets remain range-bound or correct further.
  • Maybe Modi loses and the markets crash.
  • Maybe Modi loses and the markets remain stable.
  • Maybe the general elections have no impact on the market.
  • Maybe the markets react to the elections only for a brief period and then move based on other important events and variables.

The possibilities are endless. So, while it's tempting to build a fancy narrative of what's happening and what will happen, one must be aware that it is a trap.

Over-simplistic market theories simply don't work for your investment decision-making and long-term wealth creation.

The markets may correct further. Or the bull market may resume.

The intelligent investor does not try to predict factors that are beyond his understanding and control.

So, to answer my friend's question...

I don't know who will win the elections. I don't know how the markets will react to the outcome, even though it may seem obvious that a Modi victory will cheer market participants and vice versa. Back in November 2016, nobody expected Donald Trump's victory in the US Presidential elections to be followed by a major bull run.

I don't know how the markets will progress after the elections are done and gone.

However, I do believe this is a good time to buy quality stocks at reasonable valuations. My mantra for 2019 is to buy stocks, but selectively.

Chart of the Day

What are the factors that drive stock prices higher?

One of the key factors is earnings growth. When a company delivers robust growth in earnings, the stock price is destined to rise higher.

Another factor that drives stock prices higher is the expectation of higher future earnings. Stock prices rise ahead of earnings, resulting in an expansion of the valuation multiple. In the NSE 500 price-to-earnings multiple chart I presented on Friday, it was apparent that most of the gains over the last five years have come from expansion in valuations in anticipation of higher future earnings.

A third factor that plays a key role in driving stock prices higher is liquidity conditions. If money keeps pouring into the stock markets, stock prices are likely to trend higher.

The key driver of the bull run in 2017 was a flood of domestic liquidity into the Indian stock markets.

The chart of the day shows the inflow of domestic money into equity mutual funds.

Inflows into Equity Mutual Funds at 25-Month Low

You can see the net monthly inflows rising through 2016 and surging to unprecedented highs in 2017. But the inflows slowed in 2018. After October 2018, the inflows into equity mutual funds have been dropping every consecutive month. In fact, in February 2019, the net inflows into equities, including those linked to savings scheme funds, declined to Rs 5,122 crore. That's a 17% drop from January 2019, and a steep 69% plunge from a year ago.

Happy Investing,

Ankit Shah
Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

PS: Tanushree Banerjee, editor of StockSelect, has uncovered the 3 stocks that are best placed to ride the boom in India's defense industry. Watch this space for more...

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1 Responses to "Will a Modi Victory Pave the Way for the Next Bull Market?"

KD

Mar 11, 2019

If Modi wins then corporate taxes will be reduced and taxes on diesel will be increased. Definitely, corporate earning will increase due to lower taxes and rural demand will stagnate due to very high diesel prices.

It seems that luxury businesses that caters to super rich will do very well. One should start investing in these kind of businesses because probability of him winning is very high.

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