Chris Wood predicts market correction on 'surprisingly bad outcome' for BJP, probable capital gains tax changes

According to Wood, PM Modi has made more positive differences to ordinary people's lives in the 10 years he has been in power than any other leader.

A surprisingly bad outcome for the incumbent BJP government in the current six-week-long general election, is among the two potential domestic triggers for a correction, said Jefferies' Christopher Wood in his latest GREED & fear note.

The results of the Lok Sabha election are due to be announced on June 4.

According to Wood, while the domestic or foreign media has been desperate to report any evidence that the BJP is not doing as well as anticipated, the reality is that "Modi has made more positive differences to ordinary people’s lives in the ten years he has been in power than any other leader of a government in the world today."

"This is why a repeat of the shock BJP defeat in 2004 remains unlikely in the extreme. At that time, the Sensex corrected by 17 percent in the two days after the election results on May 13, 2004. In GREED & fear’s view there would be an even worse outcome in the event of a repeat of such a shock result," Wood wrote.

It is entirely possible, if not probable, that the ruling party does not do as well as the BJP was hoping following its unexpectedly positive performance in the state elections held in November, he added.

Still, even if the BJP wins by “only” the number of seats in the last general election held in 2019, that is quite enough to run the government as the past five years have demonstrated, the note said.

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Meanwhile, a bigger risk for the market that most fund managers are discussing is whether there would be changes in the capital gains tax structure.

"Such changes could be announced in the budget which is anticipated to be announced in July after the election. The issue here is whether the tax rates will be raised or whether the period to qualify for long-term gains will be extended, or a combination of both," Wood said.

According to the current framework, short-term capital gains is levied at 15 percent and long-term gains at 10 percent with the holding period defined as one year.

In GREED & fear’s view, an extension of the period would be better than raising the rates. Another proposal being floated would be to increase capital gains tax for retail investors but not for those investing in mutual funds.

The reason that such proposals are apparently under consideration is growing evidence of retail speculation, most particularly in the options market where India has options for 182 individual stocks," he said.

Wood in the latest note highlighted that stock options notional turnover rose from Rs 123 lakh crore in FY20 to Rs 921 lakh crore in FY24 and Rs 169 lakh crore so far in FY25 beginning April 1.

"Such paper speculation is unlikely to be viewed as healthy by Modi, or indeed the BJP. GREED & fear’s probably correct assumption is that the Indian Prime Minister has a natural suspicion of those making money out of money, most particularly in a zero-sum game like options," Wood said.

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As regards the growing risk of a correction, Jefferies’ head of India research Mahesh Nandurkar noted that retail participants have a much higher concentration in small and mid-cap stocks.

Mahesh estimates structural flows from retail to the equity market at around $40bn/annum, dominated by SIPs.

Meanwhile, retail investors’ net purchases of single stocks via the NSE totalled an annualised $24bn in the first four months of this year. "All of the above is why it will be a surprise to GREED & fear if nothing is announced on capital gains tax in the forthcoming budget," the note said.

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