MC Poll Position: Adverse election outcome could derail retail party, cause sharp fall in smallcaps: Bouyant Capital’s Jigar Mistry

Some level of nervousness ahead of election results is normal. In places like West Bengal, small vote swings of 4 percent can significantly affect seat counts.

Jigar Mistry is one of the smartest emerging portfolio managers. Talking to Moneycontrol, Mistry spoke about the challenges in predicting market reaction to the election verdict, the possible impact on small and mid-caps under different scenarios, and his top three picks currently. Edited excerpts:

Some level of nervousness ahead of election results is normal. In places like West Bengal, small vote swings of 4 percent can significantly affect seat counts. Given many seats are decided by narrow margins, pre-election anxiety is expected. We've had a stellar rally influenced by factors like the Fed’s pivot and BJP's wins in state elections. So, a pullback before election results is typical.

Yes, numbers are easier to predict than human psychology. While earnings drive long-term market performance, in the medium term, market movements are influenced by earnings plus the re-rating or de-rating of PE multiples. How the market reaction will be depends a lot more on what kind of market you are looking at.

If the BJP plus NDA are not able to secure a majority of 272, then corrections in the small and micro-cap space will be sharp. You could see the valuations, at least the ones that have been re-rated, completely reverse and get into a de-rating trajectory. So earnings could continue to grow at a reasonable speed, but the share price movement could be quite wide. Larger caps may not move as much, and therefore, your incremental money could flow there. And that might be a better place to be.

If BJP and allies get more than 272 comfortably or thereabouts, then the immediate reaction in the market may not be one of celebration. If they get there comfortably, with NDA crossing 340-350, then people will assume that foreign inflow will come to India. Domestic savings are already flowing into India. Things would be okay.

Small caps are vulnerable because their valuation increases have been driven by retail investors. If retail sentiment declines due to an unfavorable election outcome, the "buy on dip" strategy may reverse, leading to a sharper fall in small caps. Retail investors hold a substantial portion of small and micro-cap stocks, and negative sentiment can cause significant market corrections.

During COVID, the combined market cap of the 3,250 micro-cap companies was Rs 5 trillion. Today, it exceeds Rs 32 trillion, with retail investors owning 49 percent directly and another 20 percent through mutual funds.

If there are policy changes, particularly from the government, we could see reversals. The market's current high valuations are not strongly backed by earnings growth but by market exuberance and low free float. If the government signals a policy shift, a reversal of the past four years' gains is to be expected.

The reason a lot of domestic money was coming in and supported the Indian markets was because of the actions that were taken by this government in terms of how they are looking at formalizing the economy. With GST flowing in, a large amount of the unorganized economy came into the organized market. That started a chain reaction that made real estate and gold a lot less attractive as assets. It also made equities, where the historical ownership is much lower, a lot more interesting market.

Now, if an alternative to this government comes through and get into policy action, which is counter to what we have seen over the past 10 years, then it suffices to say that domestic money is not here to support the market.

And globally, we still think that we are in the race for higher for longer in the interest rate cycle. And in that scenario, everything goes for a toss.

We may have borrowed some returns from the future, meaning that even with a good government, the initial reaction might be cautious as people wait to see what unfolds. The RBI and SEBI, along with the finance minister, have expressed concern about the past six to seven years, where 80% of bank lending has gone into personal loans. Some of this money may have ended up in the gaming industry or the F&O markets. The RBI has responded by adjusting risk weightages, and there have been intentions expressed to manage this situation, but no concrete actions yet.

India's market has unusual ratios of cash to F&O compared to other markets. If the authorities take steps to control this exuberance, it could lead to a short-term market downturn. Unsustainable market trends eventually correct themselves.

No, instead of using hedges, we manage the beta of the portfolio to deal with market uncertainties. For example, we have reduced our small and mid-cap exposure significantly and increased our position in large caps. This approach helps mitigate risk without the need for direct hedging.

Corporate-facing banks, housing finance companies, and telecom companies. With the Gross Fixed Capital Formation (GFCF) to GDP ratio improving, more lending will shift from personal loans to corporate loans, making corporate-facing banks a strong investment choice. Housing finance companies are likely to benefit from various policy actions. Lastly, the competitive intensity in the telecom sector seems to have peaked, and Indian telecom companies aim to increase their Average Revenue Per User (ARPU) to around Rs 300 ($3.5), which is still low compared to other markets and is the lower end of the African markets which is around $3 to $7.