By Nupur Acharya

As Indian equities are set to close out 2017 near all-time highs -- and volatility hovers near historic lows -- analysts say investors must keep an eye on politics for signs of a turn in the current bullish sentiment.

Polls will grab market attention next year as eight states, covering a fourth of the nation’s population will hold elections over the next 12 months, brokerages including Credit Suisse noted. A setback for the Bharatiya Janata Party would surprise investors betting on Prime Minister Narendra Modi winning a second term in 2019, according to Nomura Financial Advisory & Securities (India) Pvt.



Already, the current poll in Gujarat has turned into a closer than expected fight for Modi as the landmark consumption tax and last November’s cash ban stoke economic discontent in his home state. Most observers expect him to win when votes are counted Dec. 18, though his lead shrunk as the election neared.

“Market assumptions so far have been of a comfortable BJP victory in Gujarat, and that the momentum continues till 2019," Credit Suisse said in a Dec. 5 report. While general elections have a “limited direct economic impact,” changes in market sentiment could drive volatility, the firm said.

At risk is a 26 percent rally that’s made the $2.3-trillion market Asia’s second-best performer in 2017 and a nascent recovery in corporate earnings. Nomura analysts say the economy “is at the cusp of a business upcycle” with the recent government policies expected to aid the revival.

Here are some highlights from the 2018 outlook reports:

NOMURA
(Saion Mukherjee, Neelotpal Sahu and Sanjay Kadam)

Government policy reforms for long-term sustainable growth to help sustain valuation multiples Financial sector to lead earnings recovery as asset-quality concerns recede, credit growth improves Key risks to positive view are failure of economic growth to revive, spike in oil prices and possibility of the BJP government not returning to power in 2019; results of state elections to help gauge prospects of ruling party getting re-elected Overweight: Financials, autos, oil & gas, infrastructure/construction, healthcare; Underweight: IT, consumer staples, utilities and cement Top picks: HDFC Bank, State Bank, Shriram Transport Finance, Maruti Suzuki, Ashok Leyland, Mahindra & Mahindra, PNC Infratech, Larsen & Toubro, Reliance Industries NSE Nifty 50 target of 11,800 by December 2018; it closed at 10,322.25 on Monday

CREDIT SUISSE
(Neelkanth Mishra and Prateek Singh)

State elections will get more attention; it is possible that 2019 general elections are brought forward to be held simultaneously with polls in the states of Madhya Pradesh, Rajasthan and Chhattisgarh next December Growth may be slightly better than in 2017 but unlikely to improve meaningfully amid weak farm income, slow investment pick-up and continued weakness in real estate Overweight: energy, metals, PSU banks and IT; Underweight: Non-bank Finance companies, cement, discretionary and staples Top Outperformer: State Bank of India, ONGC, Tata Steel; Top underperformer: Bajaj Finance, Ultratech Cement and Dr Reddy’s Laboratories.

BANK OF AMERICA MERRILL LYNCH
(Sanjay Mookim and Nafeesa Gupta)

India joined at the hip to global tide; largest risk to equity prices into 2018 is external Streak of weak headline earnings may have ended; higher oil prices, favorable base mean 3Q/4Q numbers likely to be comfortably in double digits Government likely to consider increased social expenditure ahead of 2019 elections Unclear whether spending rise will happen in 2018 as BJP may chose to stay “fiscally conservative” if they feel confident of victory without higher spend Expenditure increase to spur demand for discretionary goods like vehicles, appliances; beneficiaries likely to be largely rural Availability of stressed assets at discount can potentially create significant value for buyers, can be big stock price drivers Cut overweight on financials, raising it for consumer discretionary, industrials, utilities and materials Increase underweight on IT, telecom and going underweight on healthcare Sensex fair value at 32,000 for December 2018