The recent Indian general election result, where the Bharatiya Janata Party (BJP) failed to secure a majority, led to a significant market reaction. On June 4, the Nifty index experienced a sharp 5.9% decline, reflecting investor concerns over the unexpected outcome. Despite this initial dip, the market rebounded, ending the last quarter up 9.7% from the post-election low.

Brokerage house Jefferies has provided a detailed analysis of the situation. They emphasize that the lack of a BJP majority introduces uncertainty, as coalition governments are often seen as less stable and more prone to policy compromises. The first two five-year terms of Prime Minister Narendra Modi were marked by a strong focus on policy implementation, a characteristic that may be diluted in a coalition setup. This raises questions about Modi's ability to maintain his effectiveness in a coalition government.

Jefferies also warns of potential market corrections, especially within the mid-cap sector. The Nifty MidCap 100 index is currently trading at a high valuation of 32.2x one-year forward earnings, compared to 20.6x for the Nifty. This discrepancy suggests that mid-cap stocks could be more vulnerable to price adjustments.

In anticipation of the new government's budget, expected to be announced during the Parliament's Monsoon Session, Jefferies predicts a shift in investment strategies. Investors are likely to favor consumption plays over investment plays, betting on the new administration's focus on populist measures. Reports indicate that the government is considering consumption-boosting initiatives worth over ₹50,000 crore (approximately US$6 billion), including tax cuts for lower-income individuals. This approach contrasts with the previous ten years' emphasis on fiscal spending on physical infrastructure.

The brokerage advises that a strategic portfolio adjustment towards consumption, particularly rural-focused plays, could be advantageous in the short term. However, they maintain that India is still in a property and capital spending upcycle. The 2004 election defeat of the BJP serves as a historical precedent; despite an initial market decline of 19% in three days, the market rebounded by 43% over the following year, driven by a strengthening capex cycle.

Also Read | CONCOR Reports 6% YoY Volume Growth in Q1 FY25, Driven by Strong Domestic and Exim Segments

Domestic and foreign investor flows have significantly influenced the stock market. Retail investor inflows surged to US$7 billion per month in the first five months of the year, anticipating a BJP victory. Domestic equity mutual funds saw net inflows rise from ₹15,600 crore (US$1.9 billion) per month in 2023 to ₹30,300 crore (US$3.6 billion) per month in early 2024. Foreign investors, who were net sellers in the last quarter, have since turned net buyers, adding US$4.95 billion since June 7.

From a macroeconomic perspective, Jefferies projects an annualized earnings growth of 16% for FY 2024-26. The banking sector, however, faces challenges with a 31 basis point year-on-year decline in net interest margins, falling from 3.7% in Q4FY23 to 3.4% in Q4FY24. This decline is attributed to regulatory pressures and a slowdown in retail loan growth, particularly unsecured loans.

The Reserve Bank of India (RBI) has room to maneuver on monetary policy, with a real policy repo rate of 1.7%, adjusted for CPI. However, the RBI, like other Asian central banks, is awaiting cues from the US Federal Reserve before making any rate adjustments.

In summary, the Indian stock market's response to the BJP's election result highlights the inherent uncertainties of coalition governments and the potential for market corrections. Investors are likely to adjust their portfolios in favor of consumption plays, anticipating populist measures from the new government. While challenges remain, especially in the banking sector, opportunities exist for foreign investors and in the broader economic growth outlook. The upcoming budget will be crucial in shaping market sentiment and investment strategies moving forward.

Join our Trading with CA Abhay Telegram Channel for regular Stock Market Trading and Investment Calls by CA Abhay Varn - SEBI Registered Research Analyst & Finance Saathi Telegram Channel for Regular Share Market, News & IPO Updates

Start your Stock Market Journey and Apply in IPO by Opening Free Demat Account in Choice Broking FinX & Upstox.