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Markets seem to be rejoicing the prospect of a Narendra Modi led National Democratic Alliance (NDA) even before the first vote is cast. Built on those expectations, Nifty has crossed 6600 and Sensex has stayed above 22000 in trading on wednesday. But is the market being over optimistic given the recent infighting in the Bharatiya Janata Party (BJP) and other parties also getting aggressive in their election campaign.
This point was raised by a Kotak Institutional Equities Strategy report written by Sanjeev Prasad, Akhilesh Tilotia and Sunita Baldawa, where they have asked the question-- What would happen if the 2014 election results disappoint?
The report says that the recent sharp move in domestic cyclical sectors and PSU stocks suggest that the market expects a favourable outcome for the NDA in the national elections. This is expected to lead to an economic recovery from current low levels and economic reforms that will address the weak financial and operating performance of PSU companies.
The strong performance by the market coincides with opinion polls indicating high probability of the formation of a NDA government. Market is expecting NDA to get 225 seats with BJP winning more than 200 seats.
However, Kotak cautions that the market would correct sharply if the results do not meet their expectations. A messy coalition of several regional parties without a common economic agenda will be very negative for the economy and the market.
The sharp move in domestic cyclicals and PSU stocks over the last one month has resulted in a lower risk-reward ratio. Following are Kotak's view on various sectors.
Automobile stocks trade at reasonable valuations and have not participated in the recent rally. Further automobile companies have sufficient buffers in case of a disappointment in national election. Kotak expects a modest improvement in volume and expects weaker global metal prices to benefit margins.
Banking stocks are trading at their 12 month fair valuation and offer limited upside. Stocks could correct significantly (up to 20 per cent) in case of disappointing election results.
Cement stocks are also trading at rich valuations even after factoring a favourable outcome of the elections.
The sharp run up of PSU energy stocks have now made them reasonably priced. In case of lower under recoveries and higher gas prices, stocks can move up further, but an unfavourable result will raise questions of diesel under recoveries and the viability of hiking gas prices which can bring the stocks down by 15-20 per cent.
Industrial and Infrastructure stocks are currently factoring in a quick revival of investment cycle leading to an earnings upgrade. Kotak says it will take time to fix the challenges in the sector. These stocks are expected to bear the brunt of an unfavourable result, falling by as much as 20-25 per cent.
