Can the Union Budget 2018 trigger a rally in stock markets - Motilal Oswal
Can the Union Budget 2018 trigger a rally in stock markets - Motilal Oswal

Can the Union Budget 2018 trigger a rally in stock markets

 

Budget impact on stock market 2017 and 2016 has been quite pronounced as we will see in the Nifty/Bank Nifty chart later. Union Budget and stock market have a long relationship. In fact, in most years the stock markets tend to overreact on the day of the budget but also the Budget has been the day when major bottoms have formed. Both in 2016 and in 2017 the market formed a near-bottom on the Budget day and went into a secular rally from there on. Considering that it has happened for 2 years in succession, there is definitely an impact of union budget on Indian stock market. 


                                                         Source: NSE

The post budget rally of 2016 and 2017..
We have plotted the Nifty and the Bank Nifty between 2016 budget day and the day prior to the 2017 budget day and then the 2017 budget day till current. The table captures the gist of our return calculations. 

Index ReturnsBudget day to Budget day Returns (2016-17)Returns from 2017 Budget day till dateTotal returns since the bottom of Budget 2016Nifty Index22.53%22.54%52.87%Bank Nifty Index39.93%28.61%84.63%# - Please note that dividend impact is ignored for simplicityThe above table is really a story of two massive post-budget rallies. The rally in the Bank Nifty is been much bigger than the Nifty per se, but that has had a salutary impact on the Nifty since the Bank Nifty accounts for nearly 35% of the Nifty. So what was the story for 2 consecutive post-budget rallies in 2 years?

The story behind the rally of 2016 and 2017..
In the year 2016, the Nifty actually made a bottom on the day of the Union Budget. The markets were impressed by 2 factors. Firstly, there was the big focus on infrastructure which was likely to have a multiplier impact on markets. Secondly, despite the commitment to increase public spending, the government had stuck to its fiscal discipline which was greatly appreciated by the institutional investors. However, year 2017 was a slightly different story. The markets were betting on the big benefits of GST to trickle down to the Indian corporate sector. Also, the markets were flattered by the positive reaction to the demonetization and almost saw that as an affirmation of the reforms process by the government. This commitment to stick to the reforms path despite impending elections received a big thumbs-up from the markets. That explains why the Nifty is up nearly 53% in the last 2 years averaging around 22.5% each year. Of course, the bank Nifty was an outperformer but then it had bigger stories like revival in earnings momentum, consumption story and the Insolvency & Bankruptcy Code (IBC) in its favour.

Why year 2018 may not result in a big bull rally like in the last 2 years?
While the government is likely to keep its focus on reforms, the markets may be slightly more circumspect in 2018. Here are 5 reasons why..

After 2 success years of 22.5% returns, the Nifty has already reached a zone where FPIs are beginning to find it fully valued. These valuation concerns will weigh on the markets, especially with a host of state elections coming up in this year.

Oil could be the big question mark for the markets. Oil impacts India in 3 ways. Firstly, it is positive for the commodity companies and that is likely to show in certain companies. Secondly, the worry is on inflation, which has already crossed the 5.2% mark. Oil has a strong downstream impact on consumer inflation. Thirdly, higher oil price means a higher import bill and a higher trade deficit. India imports nearly 85% of its daily oil requirement and the monthly trade deficit has already crossed $13 billion. The margin of safety is surely lower this year.

Over the last 2 years, the valuations have run up quite fast hoping that the earnings will eventually catch up and justify these valuations. While earnings have shown some green-shoots in the last 2 quarters, it will still require a herculean effort to be able to justify current valuations via growth. Markets will play cautiously.

Flows could be the big issue for India. In the last 2 years mutual funds have been buying big time but FPIs still have a greater control over the floating stock of large cap companies. If the Fed hikes rates further, there may be a rush to move risk-off and that may impact EMs like India. Also from an FPI perspective, other emerging markets are available at cheaper valuations compared to India.

Liquidity will eventually make or break the market. We could see a lot of central banks unwinding their bond portfolios and the resultant impact will be a liquidity crunch in markets. Normally, equities have reacted negatively to liquidity shortfalls and that is bound to happen during the year.

In a nutshell, it may be hard to see a post-budget rally of the same magnitude as the last two years. More than domestic concerns, the global concerns may be actually overwhelming. Of course, there will still be pockets of outperformance but a big broad level rally does look rather difficult.

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