Morgan Stanley's Ridham Desai shares how market prices in 'continuity' ahead of polls

Even as the general elections slated for the next year will be a key risk, the markets is likely to price in continuity, and basis its trade on the outcome, Ridham Desai, MD and head of India equity research, said in an exclusive interview with Moneycontrol.

The market's tendency in the past 35 years has been to price in continuity. “The market as an animal doesn't like discontinuity. So that's what it will price in - continuity. And then, if you get discontinuity, it will react like it did in 2004. It did the opposite in 2009," he said.

Desai said it is impossible to predict at this point how the markets will price in the local election risk since the event is six months away. “It's hard for me to say this now, I don't know what will be priced in when we arrive on that election counting day. So, it will depend on that. And then let's not forget that there are so many global things that can happen in the interim."

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“My base case is that the market will trade a continuity in government and then decide what to do about the actual result after that. If it has priced in continuity and that's the outcome you get, then there's not much reason for the market to immediately respond. It's not going to go up a lot if it gets the outcome it has already priced in,” he said.

“But if the market has priced in continuity and there's discontinuity, then we should be ready for a pretty strong downside move on the market.” On the flipside, if the markets for some reason, price in discontinuity and gets the opposite, things could be different, but that is “not my base case” Desai said.

While there are several imponderables - how the Fed will steer interest rates, how crude oil prices will behave, if China growth will rebound, and if the US economy softlands or falls into recession - all these will be vital in setting the market direction, the outcome of the general elections next year will be a key event risk for India. This is because the bullish narrative surrounding India’s growth is seen as an outcome of the current administration’s ability to push ahead with the policies, initiatives to propel growth and navigate the geo-political situation well.

Watch full Ridham Desai interaction here

According to Desai, there are several ways to negotiate this risk. At the portfolio level, investors could buy IT services stocks, which could lend a little bit of stability to the portfolio. The other way is to play it through the options market by use hedging strategies.

“You could hedge your portfolio to cover the risk of a downward move in the market. Or, you could also take the risk of going into cash and stay out of it, because you don't want to suffer downside risk and then come back depending on what the election outcome is,” Desai said.

Every investor has to choose his or her way to cover the risk, based on their risk appetite.

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