Agents of Change

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Manas Punhani's picture

Agents of change

In 2014, billions of people representing more than 40% of the world’s population voted for new government leaders. While India went to the polls in the heat and dust of May, Indonesia voted for its new government in July.  In this paper, I will be using the case studies of India and Indonesia to study the impact of a change in government leadership on financial markets.  I would be arguing that new government leaders have a significant effect on financial markets in the short term due to underlying expectations and sentiment, but that in the long run, global factors and fundamentals such as profit margins, cash flow and earnings growth overwhelm any potential deviations caused by political transitions.  For the purpose of this analysis, I will be dividing the timeline into three distinct phases – Phase I: the period prior to political transition; Phase II: the transition in government leadership and Phase III: post-transition. There is, however, an important caveat to consider: making generalizations about political trends across countries involves great risk.


Early optimism against the backdrop of slow growth: Phase I

There were common themes in many of Asian countries that went to polls in 2014: inadequate infrastructure, inflation, external deficit, and structural impediments to growth among other macroeconomic imbalances. In India and Indonesia in particular, economic outlook looked fragile. The outgoing governments of Prime Minister Manmohan Singh’s and President Yudhoyono’s had failed to devliver focused policy responses and structural reforms causing real GDP growth to slow down to 3.2%[1] and 5.3%[2] respectively.

Against this backdrop, financial markets viewed a change in guard in the political leadership as a catalyst for much needed reforms.  Emergence of business-friendly and pro-reform leaders like Narendra Modi and Joko Widodo as front-runners in elections reinforced these expectations, thereby leading to a “hope” rally in the financial markets.  Modi and Jokowi had financial markets believe that they were the right leaders to reinvigorate the two emerging economies. As a result financial markets in India and Indonesia soared; the benchmark index BSE Sensex and IDX Composite gaining 13%[3] and 19%[4] respectively in the six months leading up to the elections. 

Financial Markets respond to the electoral verdict: Phase II

While the pre-election Phase I is influenced by a build-up of expectations, Phase II on the other hand depends on the electoral verdict itself. The decisive sweeping of the polls by Modi and Jokowi gave new wings to the “hope” rallies. For their part, both leaders supported market sentiments by promising to introduce structural reforms, cut red tape and attack graft.  

From the above, one can safely infer that the primary driver of the performance of financial markets in Phase I is early optimism, while in Phase II electoral outcomes play a significant role in giving directions to the markets. As financial markets despise uncertainty, electoral verdict which leads to stable political leadership further boosts confidence amongst investors that the new government will act on the reform agenda promised in their election manifesto. In the wake of new stable pro-reform governments, India and Indonesia were among the best performing stock markets for the election year of 2014; the benchmark BSE Sensex increased 34% while the IDX Composite was up by 25%[5].

Fundamentals Trump Emotions: Phase III

It has been argued that a combination of fundamentals and emotions drive the financial markets[6]. In Phase I and II, there is more emphasis on emotions i.e. expectations and sentiments, that the political transition would positively impact the long-term growth potential of asset markets. Investors choose to focus on issues such as political change and reforms rather than on valuations and real earnings growth. In contrast, the performance of financial markets in Phase III becomes dependent on two elements: fundamentals and global factors.

The rallies in Phase I and II make the financial markets extremely overvalued. India and Indonesian benchmark indices are trading on a one-year forward P/E of 15.6 and 15.87 respectively, i.e. a premium of more than 35% to the MSCI Emerging Markets Index[7]. Moreover, an analysis of the price-to-earnings (P/E) ratio, the cyclically adjusted price to earnings (CAPE) and the price to book (P/B) ratio reveals that as compared to historic data, markets in the two countries are expensive[8]. The earnings momentum is too low to justify the present valuations. In Phase III, financial markets take cues from whether the well-intention reforms of the new government have translated into meaningful improvements in fundamentals like earnings growth, EPS, P/E etc. If markets discover that the promised reforms have not been able to make an impact on improving the trajectory of fundamentals’, they will consequently correct downwards. In other words, as election euphoria dies down, market value will revert to levels justified by the underlying economic fundamentals. For instance, in India in 1999, BJP-led National Democratic Alliance came to power promising to deliver on a range of policy changes. The financial markets responded well, with the benchmark BSE Sensex jumping nearly 63%[9] in the election year. However, the new government tripped on fulfilling its promises and corporate earnings were below expectations. Consequently in the following year, the Sensex had dropped 26%.[10]


Besides, even if the new government does manage to stabilize macroeconomic imbalances, global factors can still pose a major risk to financial markets in Phase III. Last year, fears of US Federal Reserve tapering i.e. rolling back its asset purchase program sent jitters through Asian economies like India and Indonesia. Both markets saw a brief slump amidst fears that liquidity will be adversely affected if the Federal Reserve wound down its tapering program[11],[12]

Notably, fundamentals of Indian stocks in the post transition period have improved as a result of lower inflation and lower interest rates on account of a combination of falling oil prices and structural reforms. Consequently, BSE Sensex reached a new all time high of 29278.84 on 24th January 2015[13]. In Indonesia, on the other hand, global factors like collapse of commodity prices adversely affected fundamentals thereby creating a downward pressure. As a result, the IDX Composite has weakened since its peak in September 2014.



In a globalized world where the economies of countries are interrelated and interdependent, change in political leadership has a limited short-term influence on financial markets. New government leaders may cause markets to become temporarily inefficient i.e. stock-prices may not reflect true fundamentals. However in the long run, financial markets shift their focus to individual companies’ key fundamental results such as growth in earnings, profit margins and cash flows.

The earlier rallies fueled by sentiments rather than real valuations face obstacles as financial markets start asking whether the expectations have any steam left or are they running ahead?  Have reforms of new government leaders really made a difference to the fundamentals that drive stock prices? The financial markets either correct or perform well on the basis of answers to these questions.

So, while new government leaders can play a pivotal role and drive the markets in the near term, the rally will not be sustainable without the fundamentals matching the expectations. The sustainability of the wave in the financial markets thus depends on whether new governments are successful in improving political, business and social frameworks conducive for growth in the economy and corporate earnings.




[1] The Central Intelligence Agency. The World Factbook. > (date accessed: January 24, 2015)

[2] The Central Intelligence Agency. The World Factbook. < > (date accessed: January 24, 2015)

[3] Google Finance, BSE Sensex Index, Historical data, April 2013- March ‘14. < > (date accessed: January 24, 2015)


[4] “Jakarta Composite Index Historical data” Jan 2014-June 2014



[5] Ficenec, John. “Which country’s stock market is perfoming the best this year?” The Telegraph 7th November 2014. Web. (date accessed: January 24, 2015) <


[6] Dunne, Peter and Zholos Andrey. “The Value Relevance of Sentiment”>


[7] Shah, Ami. “Indian equities at a premium to EM Index, but not yet expensive.” The Mint 27th May 2014. Web. (date accessed: January 24, 2015) <


[8] Waslander, Simon. “Indian equities seem vulnerable.” The Foresight Investor. 26th July 2014. Web. (date accessed: January 24, 2015) <




[11] Bisara, Dion. “JCI falls on Fed Tapering concerns.” The Jakarta Globe November 21, 2014. Web. (date accessed: January 24, 2015) <>


[12] Shah, Ami. “Sensex slumps as Fed indicates tapering.” The Mint November 21st, 2014. Web. (date accessed: January 24, 2015) < >


[13] Arora, Pankaj. “Sensex rises for seventh day to new high, gains 0.9% as it joins global rally fuelled by ECB’s quantitative easing plan” The Economic Times 24th January, 2015. Web. (date accessed: January 24, 2015)