Poll debacle: Stock market’s love for BJP comes at a heavy cost

Though the BJP emerged as the single largest party in the Indian Lok Sabha, it has not managed to win nearly as many seats as the exit polls predicted, nor as many as it would have won in the 17th Lok Sabha elections. This has forced the stock market to temper its optimism. This is also due to the fact that the BJP does not have a majority on its own. As a result, the S&P BSE Sensex closed down 5.7% on June 4. Shares of public sector companies and Adani Group bore the brunt of the selling.

Given the election results, what does the near future hold? A big reason for the surge in stock prices over the past few years has been the massive increase in sales and profits of publicly traded companies. Some of this rise is due to the efforts of companies, but much of it is due to factors that are not easily replicated.

The increasing formalization of the economy after demonetization, the spread of COVID-19, and poor implementation of the GST have all hurt India’s informal sector, but listed companies have thrived. Moreover, very low interest rates during the pandemic helped companies reduce interest payments and outstanding borrowings. In September 2019, the government cut corporate tax rates, boosting profits. Also, import duties increased, making the domestic market more attractive to companies.

Moreover, during the pandemic, global central banks printed money to lower interest rates, leading to heavy inflows into Indian equities in search of higher returns. From April 2020 to June 4, 2024, foreign institutional investors invested in Indian equities on a net basis. ₹It has Rs 2,79,369 crore in Indian equities but has been selling shares since April.

In fact, domestic investors too have turned to equity investments post-Covid. The number of demat accounts has surged from 39.4 million in December 2019 to 154.4 million in April 2024.

In addition, domestic institutional investors (DIIs), which consist of investment trusts, insurance companies, pension funds, banks, etc., and manage funds collected from individual investors, ₹6,55,262 crore in equity from April 2020 to June 3, 2024. From April 2024 to June 3, 2024, they invested a net amount. ₹1,01,833 crore. Also, the rise in smartphone investment apps, fuelled by cheap internet connectivity, is driving interest from individuals.

But the bigger problem is that the number of new retail investors in stocks cannot continue to grow at such a fast pace, and interest rates are no longer low.

So what does the future hold? Stock prices, after all, reflect a company’s expected earnings. According to data from the Centre for Monitoring the Indian Economy, net sales of around 4,800 listed companies in 2023-24 were 6% higher than in 2022-23, but still significantly lower than the surges in 2022-23 and 2021-22.

But net income growth has remained steady as spending has grown at a slower pace than sales. In fact, net sales for more than 3,700 publicly traded non-financial services companies grew by less than 1% in 2023-24.

In other words, sales appear to be keeping pace with the slowdown in private consumption spending in the economy, which is expected to grow at 8.5% (not adjusted for inflation) in 2023-24, the slowest growth rate since 2004-05, excluding the pandemic year of 2020-21.

Consumption growth has slowed because it is largely financed by household borrowing: Household debt is “likely to exceed 6% of gross domestic product” for only the second time in history in 2023-24, according to economists Nikhil Gupta and Tanisha Radha of Motilal Oswal.

Indeed, households cannot fund consumption endlessly through rising borrowing, which is reflected in slowing sales growth, which, if sustained, will ultimately hurt profit growth.

Finally, equity valuations are on the rise. For 2024-25, the price-to-book (PB) ratio of stocks in the BSE 500 index is at its highest since 2007-08. PB multiple is a valuation measure.

But these are all theories and it didn’t matter as retail investors continued to pump money into stocks. Will they continue to do so or will the realisation that valuations are too high become widespread? We’ll probably find out in the coming days. That said, it’s worth recalling what happened on May 17, 2004, when it became clear that the NDA government led by Atal Bihari Vajpayee would not be coming to power again.

Markets that had been crazy about the BJP fell dramatically, with the Sensex dropping 11.1%, only to recover most of the losses two days later on the perception that Indian governments rarely dabble in economic policy and there is continuity on that front.

At the time of writing, the BJP-led NDA is expected to return to power at the centre, albeit well short of a majority.

Of course, like investing, there are no guarantees in politics, and diversification across and within investments remains the best strategy in the investment world, one that even previously naysayers are perhaps beginning to understand.