The record-setting rally in Indian shares is likely to slow down in the coming week as fatigue sets in and investor focus turns to earnings outlook to justify more runaway gains. There are already signs of this happening but the market undertone remains decidedly bullish in the run up to national polls.

General elections spread over April and early May have triggered a massive increase in spending, estimated at about $5 billion (Dh18.4 billion) to woo more than 800 million people eligible to vote in the world’s largest democracy. The expenditure should boost the outlook for companies, particularly for broadcast media, utility vehicles and a host of consumer goods makers.

Riding on the expected revenue bonanza from the spurt in spending large foreign funds have poured more than $2 billion into Indian shares over the past 20 trading sessions. The inflow has propelled stocks to a series of all-time highs, a rather unusual phenomenon ahead of elections whose outcome has the potential to make, or break, hearts and investment bets.

The buying spree has also been spurred by opinions polls that showed Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) as the most likely to form the new government in New Delhi. The BJP and its prime minister nominee Narendra Modi are seen as market friendly, with the ability to act decisively to boost investment.

In the latest bout of record peaks, the top-30 Sensex hit 22,000 for the first time ever on Monday, while the broader 50-share Nifty climbed above 6,550. Both the benchmarks, however, met with resistance and snapped a run of three weekly gains and closed lower.

Earnings growth

“Indian equities currently trade at a 40 per cent premium to emerging markets and at the high end of the relative historic trading band. Consequently, we believe that further sustainable gains for

Indian equities in the benchmark will likely have to be driven by superior earnings growth,” analysts led by Bharat Iyer at JP Morgan wrote in a report dated March 12.

The US investment bank said that Indian shares delivered a compounded annual growth rate (CAGR) of 17 per cent compared with 13 per cent for emerging market. “Annualised earnings growth for both indices was 10 per cent, suggesting that the superior gains in Indian equities were driven mainly by valuation re-rating.”

It also noted that traded value in equity markets jumped over the last fortnight, buoyed by expectations of a decisive mandate in the national elections.

The Sensex ended the week down 0.5 per cent at 21,809.80, after hitting a record 22,023.98 on Monday. The Nifty closed down 0.3 per cent at 6,504.20, off an all-time high of 6,562.85 reached on Tuesday.

“With valuations close to justifiable levels, we believe Indian equities will perform in line with earnings growth. Over FY14-15, we expect a Sensex EPS CAGR of 15.9 per cent. This implies a Sensex target of 24,800 by March 2015 or 24,000 by end-2014,” says Manishi Raychaudhuri, Asia-Pacific strategist at BNP Paribas Securities.

“For India, the risk of political uncertainty after elections, notwithstanding the current opinion polls predicting a strong showing by the BJP, remains,” said Raychaudhuri who has an overweight rating on Indian equities.

Capital flows into India, Taiwan and Indonesia have been on the rise since late last year, while South Korea and Thailand have seen outflows.

“We believe such divergence in flows within Asia is likely to continue for the foreseeable future, with the key to outperformance being overweight in markets set to gain flows. As of now, we are comfortable with our positioning — with overweights in India, Taiwan and Indonesia,” Raychaudhuri said.

Feel-good spin off

For the Congress-led coalition in New Delhi struggling with the slowest economic growth in a decade and tough electoral fight, the feel-good sentiment in the market has come as a boon. The government hopes to raise about $500 million by selling partial stakes in 10 state-run companies through an exchange traded fund (ETF) which will be operated by Goldman Sachs.

“This ETF will give the government a new vehicle to sell stakes,” Alok Tandon, joint secretary in the Department of Disinvestment, said at a news conference on Friday. “We’re hopeful of good retail investor response.”

The Central Public Sector Enterprises ETF aims to collect up to Rs30 billion from retail investors, domestic institutions and foreign funds, between Tuesday and Friday.

Plans are also afoot to raise another Rs30-40 billion by selling a stake held by a state fund in private-sector Axis Bank, Tandon said.

Although the ETF route for divestment was initially planned last year by Finance Minister P. Chidambaram, its launch was stalled by shaky stock markets.

Market expectations

Economic data is also beginning to underpin markets. After contracting for three straight months, industrial production (IP) nudged higher, albeit just 0.1 per cent, in January beating market expectations.

“Based on the better-than-expected IP data we revise our estimate of the first quarter of 2014 GDP to 4.6 per cent from 4.4 per cent earlier. We think that there could be some near-term upside to activity data due to election-related spending,” Goldman Sachs economists Tushar Poddar and Vishal Vaibhaw said in a report.

Price pressures are easing but the Reserve Bank of India (RBI) is unlikely to lower rates in the near term. Consumer price inflation dropped for a third consecutive month to a 25-month low of 8.10 per cent in February from 8.79 per cent in the previous month, while wholesale price inflation fell to a nine-month low of 4.68 per cent from 5.05 per cent.

“We do not expect any rate action by the RBI at its April policy meeting. However, we continue to think that the RBI will raise policy rates by 50 basis points in H2 2014 in order to contain inflation expectations and to mitigate the impact of elevated rural wage growth,” Goldman Sachs said.

The writer is a journalist based in India.