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With exit polls indicating a landslide victory for the  Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA), market and investor reactions need to be segregated into short and medium-term rally.

Immediate term -- a short rally

A short market rally is on the cards on the day of the results (June 4), especially if final numbers align closely with those predicted by the exit polls, given  that the markets were a tad nervous about the final numbers amid reports of BJP’s dwindling prospects in states, such as Karnataka, Bihar, and Maharashtra. Traders and foreign institutional investors (FII), which had trimmed their positions ahead of elections, would look to go long, bolstering markets during this week. FII are largely Neutral to Underweight across sectors barring Financials and Consumer Staples.

Immediate impediment -- rich valuation pricing in policy reforms

With likely third term for Prime Minister Narendra Modi-led NDA, domestic and global investors are anticipating an aggressive reforms agenda that can catapult India into the next orbit of growth. India’s markets are trading at a premium to all Emerging Market (EM) peers, especially heavyweights, such as China & South Korea, and to its historical past.

Forward earnings do not justify these valuations, especially in sectors that are linked to government policy actions, such as defense, railways, and power. Earnings need to catch up so that after the initial celebration of the election results, markets can potentially see profit-booking. Further upside in repeat names looks unlikely, as fundamentals are not in sync with the stock prices.

Evolving goalposts; market narrative likely to change post Budget

The first five years of the NDA government during FY14-19 were different from the subsequent five years of FY20-24 in terms of policy focus. FY14-19 were more skewed toward social & rural agenda, and FY20-24, notwithstanding the COVID-19 related disruption, saw significant increase in capital expenditure, primarily in railways, defence and roads. For the next five years, we expect rail freight, maritime, urban housing, urban infrastructure, new energy, efficiency capex in power and GST reforms to be the new emerging growth areas.  

Selective plays amidst peak valuation

• We remain positive on Mid & Smallcap spaces due to benefits from government-led capex, but high valuations suggest a selective approach post-elections. Favorable conditions like the RBI’s dividend payment and likely reduced borrowing suggest lower market rates, benefiting Real Estate, Banks, and Autos. Global trends support metals and data centers, while La Niña should boost rural and agriculture sectors.
• Relative underperformance of banks provides valuation comfort which is corroborated by our “What’s in Price” model. With private capex at the cusp of revival, we prefer private over public banks.

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