Is the stock market reflecting everyone's excessive euphoria on election results?

There is a well-known myth in the stock markets - usually touted by 'experts' when the markets are moving up. It goes something like this: the stock markets always discount the future.

Nothing could be farther from the truth. Just flashback to the month of September 2007. The sub-prime crisis had begun to affect the financial sector as far back as in Feb 2007.  By the summer, it had all the signs of a full-blown crisis.

Indian stock markets had the grand finale of the bull run between Oct - Dec 2007. The markets should have fallen instead because the future was bleak. What the market really does is discount the hopes and aspirations of the buyers and sellers.

The UPA won a mandate that even surprised them. The decimation of the Left parties will surely lead to hastening of the financial reforms process. The sidelining of the third and fourth fronts by the electorate means a comparatively stable government with a set of coalition partners who won't be able to pull much weight because of the few seats they hold.

Please remember that the new government hasn't been formed yet. After it gets its house in order, it isn't going to rush into reforms and privatisations. A budget will need to be placed and approved. That will take 4-6 weeks.

There may be a strong dose of taxation to cover the huge deficits caused by loan waivers, subsidies, pay increases. The Congress party policies have always been socialistic and their poll plank of concern for the 'aam aadmi' ('average Joe') will need to be catered to. That may not be palatable for market participants.

Does all that justify a historic, first ever, double upper circuit in the Indian stock markets, followed by suspension of trading for the day? The video footage of cheering, table-thumping, laptop-kissing traders and business media analysts would probably indicate a resounding  'YES'.

But look at the volumes traded. Barely Rs 3000 Crores. Most of it in F&O. That  seems like a desperate attempt at short covering rather than frenzied buying by investors. Today's up move close to the BSE Sensex index level of 15000, followed by a flat close means there were as many sellers as buyers.

In this post in Feb '09, I had categorised financial news into good, great, bad and worse and discussed their effects on the stock market and advised investors about what they should do.

Where does news of election results fit in? Regular political news have very little impact on the markets - other than wars and terror attacks. But news of a surprising election result bringing back a pro-reform team without the excess baggage of the Left parties is definitely 'good news' for the stock markets.

Why isn't it 'great news'? Not yet. That may happen after a year or two if the pace of reforms and divestments from public sector companies really push-start our economy forward to 9% GDP growth.

Till then, we have to contend with results season. Most companies have postponed results declarations till the end of June '09. Many results will be awful. The real estate and infrastructure companies that have seen an unjustified spurt recently will face selling pressure. (Punj Lloyd has already declared a huge Q4 loss.)

My advice to investors is to stay calm, not feel 'left-out' and use the temporary price spurt on 'good news' to get out of non-performing stocks. Saner voices will prevail and euphoria will evaporate.

The BSE Sensex index is looking overbought. It may not go down to 8000, but may see 10000-12000 levels in the near future. That will be a better time to start buying.