Poll result debacle: The stock market’s love for the BJP cost it dearly

While the BJP has turned out to be the single-largest party in the Lok Sabha, the number of seats it has won is nowhere near the number forecast by exit polls or the number it had in the 17th Lok Sabha. So, the stock market has had to tone down its over-optimism. An added factor is the BJP not getting a majority on its own. Given this, the S&P BSE Sensex closed down 5.7% on 4 June. Stocks of public sector units and the Adani Group bore the brunt of the selling.

With election results factored in, what does the immediate future hold? A major reason for stock prices surging in the past few years has been a substantial increase in sales and a massive increase in profits of listed companies. While some of this rise can be attributed to the efforts of companies, a lot of it has been because of factors that are not easily repeatable.

The increasing formalization of the economy after demonetization, the spread of the covid pandemic and weak implementation of GST all hit India’s informal sector, but listed firms did well. Further, very low interest rates during the pandemic helped them lower their interest expenses and outstanding borrowings. In September 2019, the government cut the corporate tax rate, boosting profits. Also, import tariffs rose, making the domestic market more attractive for companies.

Also read: Will PSU stocks face more sell-off pressure after a 25% drop?

Further, during the pandemic, global central banks printed money to drive down interest rates, leading to a lot of money coming into Indian stocks in search of higher returns. From April 2020 to 4 June 2024, foreign institutional investors invested a net ₹2,79,369 crore in Indian stocks, though they have net sold stocks April onwards.

Indeed, domestic investors also turned to investing in stocks after covid. The number of demat accounts jumped from 39.4 million in December 2019 to 154.4 million in April 2024.

Further, domestic institutional investors (DIIs), which comprise mutual funds, insurance companies, provident funds, banks, etc, and who invest money collected from retail investors, invested a whopping ₹6,55,262 crore in stocks from April 2020 to 3 June 2024. From April 2024 to 3 June 2024, they have invested a net ₹1,01,833 crore. Also, the rise of smartphone investing apps, fuelled by cheap internet access, has led to higher retail interest.

Nonetheless, the larger point is that the number of new retail investors in stocks can’t keep rising at this fast pace. Also, interest rates are no longer low.

So, what does the future hold? Stock prices ultimately are a reflection of the expected earnings of companies. Data from the Centre for Monitoring Indian Economy shows that in 2023-24, the net sales of around 4,800 listed firms rose 6% from 2022-23, considerably lower than the jump in 2022-23 and 2021-22. 

However, growth in net profit has stayed robust, thanks to expenditure rising at a slower pace than sales. In fact, in 2023-24, the net sales of more than 3,700 listed non-financial services companies grew less than 1%.

So, sales seem to be catching up with the slowdown in private consumption expenditure of the economy. In 2023-24, it grew 8.5% (not adjusted for inflation), the slowest since 2004-05, other than the pandemic year of 2020-21. 

Also read: Markets down 5%: Here's how markets have performed on previous election result days

Consumption growth has slowed down primarily due to a lot of it being financed through household borrowings. Economists Nikhil Gupta and Tanisha Ladha of Motilal Oswal note that in 2023-24, only the second time in history, household debt has “likely crossed 6% of gross domestic product."

Indeed, households cannot endlessly finance consumption through higher borrowing. And that’s reflecting in the sales growth slowdown. If this goes on, it’ll eventually hurt profit growth.

Finally, stock valuations have been in frothy territory. In 2024-25, the price-to-book (PB) ratio of stocks that make up the BSE 500 index has been the highest since 2007-08. The PB ratio is a valuation measure.

But all this is theory, which hasn’t mattered as retail investors have kept pouring money into stocks. Will they continue to do so, or will the realization that valuations have been stretchy set in? Clarity is likely to emerge in a few days. Nonetheless, it’s worth remembering what happened on 17 May 2004 when it became clear that the Atal Bihari Vajpayee-led NDA government wouldn’t be voted back to power. 

The market, which was in love with the BJP, fell dramatically, with the Sensex falling by 11.1%. Two days later, it recovered most of the losses upon the realization that governments in India rarely fiddle around with economic policy, and there is usually continuity on that front.

Also read: Election Results 2024 Market Close Highlights: Market ends drastically lower as Sensex down 4,380pts, Nifty at 21,880

At the time of writing this, the BJP-led NDA looked set to return to power at the Centre, though with a considerably lower majority.

Of course, there are no guarantees in politics, like in investing, and diversification across and within investments remains the best game in investment town, which is something that retail investors who had been in denial have perhaps begun to understand.