BJP's UP win won't bring 2014-like exuberance for markets: Dhananjay Sinha

"The Modi trade, post landslide victory of BJP in 2014, catapulted Nifty index to new high of 9000."

The outcome of the recently concluded state elections with a strong mandate for the BJP, specially the Uttar Pradesh, has rekindled hopes of another big rally similar to the one we saw post the general elections 2014. The resounding verdict in UP is unambiguously a mandate for Mr Modi. The Modi trade, post the landslide victory of the BJP in 2014, catapulted Nifty index to a new high of 9000, translating into a gain of 50%.

Bigger gains, however, were seen in mid-and small-caps, where resurgence of retail participation saw indices rising by over 150%. The question is whether the market can respond to the UP election with similar fervor. The answer lie in understanding the factors behind the earlier rally since 2014. Firstly, the backdrop of the post 2014 election rally was a period of uncertainty on both domestic and global fronts. Domestic outlook was clouded by macro vulnerabilities arising from high inflation,  slowing growth and political instability.

Globally, uncertainty arising from ending of US quantitative easing weighed on market sentiment. So the adverse backdrop created a strong case for a sentiment revival, specially with the US Fed dithering from rate normalisation for a long time. Decline global crude prices also bolstered the perceived benefit for India fundamentals.

The current backdrop is considerably different.

The expected gains in earning for Indian equities has belied with EPS for benchmark indices remaining unchanged for nearly three years, with select sectors rebalancing declines in others. This has contributed to the fact that average earnings growth for NIFTY has been just 4.5% since FY08. Also the popular Modi trade which captured hopes of revival in investment cycle and other domestic deep cyclical sectors have not panned out as expected.

The key issue now is whether the earnings trajectory will be better going forward or not, and whether the trailing PE multiple of 23x is already pricing in a growth better outlook. My sense is that a significant re-rating is unlikely even as I believe that a reflationary fiscal outlook and normalisation of demonetisation shock will yield better demand scenario. This will likely generate better earnings performance of around 10% compare to the stagnancy we saw over the past three years. It will however, be lower than usual optimistic consensus projection of 15-20% that we have seen over that past 7-8 years.

Second, there are clearer sings of reversal of low global interest rates with probability of quicker rise in US Fed rate than previously thought. The inflation surprised across the world, particularly in Emerging Markets and Europe, has been on the higher side, which fortified indications that global risk free rates are now rising. Hence, near zero global rates, a factor supporting higher valuations despite lack of earnings growth, is seen receding in the future. Hence, from India standpoint earnings delivery will be critical. Thirdly, on the domestic from we are probably heading towards higher inflation with Feb'16 WPI inflation rising to 6.6%, i.e back to Dec 2013 levels, which will crate pipeline inflationary pressure.

Also, with adverse political backdrop of 2013 absent now and multiples already on the higher side, the incremental impact of the blockbuster performance of the BJP in UP election will be far lesser than the propulsion the 2014 landslide victory provided.

At the end, it is likely that if the Fed rate normalisation is seen to be less disruptive, market sentiment may remain supportive. Importantly, we have seen that even while FIIs have been net sellers in India debt market in FY17, flows into equities have remained somewhat positive.

From earnings visibility stand point, greater policy support to rural economy and agriculture sector along with cyclical revival in advanced economies are likely to provide opportunities. Hence, the constituents of the earnings leaders post the UP-election victory of Mr Modi will also be very different from what the market expected as a fallout from his 2014 magnum opus.

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The author is head of institutional research, economist and strategist at Emkay Global Financial Services. The views expressed are his own