Impact of election results on stock market: Are Modi stocks the best bet?

In anticipation of Prime Minister Narendra Modi's hattrick in the Lok Sabha election, a basket of stocks that can benefit from favourable government policies are in the limelight today. Being basketed as "Modi stocks", the category is dominated by PSUs but also includes stocks of private companies.

Related mostly to domestic cyclical sectors such as infrastructure, industrials, defence, manufacturing, capital goods, and power, Modi stocks are direct beneficiaries of existing as well as expected policy measures from Modi 3.0.

Modi stocks in the PSU universe include the likes of HAL, Bharat Electronics, HPCL, GAIL, REC, Power Grid Corporation, SBI, Container Corporation of India, PNB, NTPC, SAIL, etc.

Non-PSU Modi stocks are Bharti Airtel, Indian Hotels, ACC, Adani Enterprises, Adani Ports, Reliance Industries, L&T, Vodafone Idea, among others, according to a list of 54 Modi stocks prepared by CLSA.

PSU stocks have been rallying non-stop since the last one year on the back of multiple triggers like attractive valuations, improving order books, clean balance sheets, strong fundamentals and the government's focus on leveraging the strength of 'sarkari' companies.

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The market capitalisation of PSUs as a percentage of total m-cap has reached 17% vs 14% in the last election year. The historical 20-year average is 21%, implying enough growth headroom for PSU stocks to grow from current levels.

Monday's session saw the BSE PSU index ending nearly 8% higher with power and bank stocks leading the list of winners. But this isn't the first time. Back in the 2014 election, the PSU index had rallied 82% in 10 months while in 2019 PSUs had seen an 18% upside in 7 months.

In both cases, PSU stocks topped out a few weeks after the election results in the month of June. Analysts expect this in June or July, before the budget in July.

"Many narrative and PSU stocks are trading at outlandish multiples and are factoring in optimistic volume and profitability assumptions. A large BJP victory may sustain rich-to-bubble multiples in parts of the market (automobiles, capital goods, PSUs) for longer, but we would be surprised if many of the lofty embedded expectations come to fruition," said Sanjeev Prasad of Kotak Institutional Equities.

Analysts, therefore, recommend booking profits in Modi stocks for investors with a horizon of a few months.

"But, if your horizon is long enough, then you do not really need to do that because there will be correction, there could be deeper corrections of 10-20% also sometime when the global market construct corrects, etc, but I think even in the global context seasonally June to September we are entering into a phase where normally, like 9 out of 10 years, we have not seen big corrections historically," says independent market expert Sandip Sabharwal.

Following the recent rally, the valuation of PSU banks have shot up to 12.2x, which is at a 8% premium to its upper Standard Deviation band and draws parallels to FY17 valuation that preceded three years of negative performance.

"Furthermore, the PSU Index currently attributes 37% of the price to long-term growth expectations, above historical highs of 35% in FY17. The overarching bullish trend for PSU may moderate, but there remain pockets of opportunity that can drive a fresh leg-up to the rally and deliver huge returns," Elara Capital said.

Beyond the popular PSU stocks, brokerages are also cautious about mid and smallcap companies which are direct beneficiaries of government-led capex.

Due to the huge disconnect between price and fundamentals, the broad-based rally in this space would normalize post elections and the plays would be selective, Elara said.

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(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)