Reacting To Election Results - A Temptation Best To Be Avoided
Timing the investment
How do you think equity markets will perform post-election results? Should one wait for the results before investing in equity?
This has always been “The Topic” every time the general elections are round the corner, whether the discussion comes up informally among the friends, colleagues or formally during interactions with advisors, private wealth managers or the HNIs. While the experience cautions you not to get swayed by this false presumption of the questioners that you are an expert on market and will have a precise answer, I thought the historical data may throw some messages to handle these discussions in a satisfactory way. Last 3 elections results and market behavior on the first day, second day to 180th day and over 15years ( 2004-2019), 10years (2009-2019) and 5 years(2014-2019) is shown in Table 1, below.
The short term reaction of the market tends to be very volatile depending on the consensus expectations and the positive or negative surprise that actual results bring with respect to that. For e.g. in 2004 the weak election results led to poor sentiment and 6% fall in the broader market indices. Had the investor panicked and sold off, he/ she would have lost an opportunity to make upward of 17% over the next 179 days (~10% gain at the end of 6 months net of the 6% fall on day one). The S & P BSE Sensex returned 14.4% (CAGR) over 15 years for those who would have invested after the fall of day 1, the returns for the ones who were invested before the results were also strong at 13.9% CAGR, beating other asset classes.
The other two occasions, the market was positively surprised and not only those who were invested before the election results earned handsome returns over the 10 year and 5 year period but also those who invested on the day 2.
Thus, the data suggests that election results have thrown surprises. One should focus on asset allocation more than wasting time in forecasting the results and deciding on the investment. There always has been interplay of many factors like the fundamentals, business, macro and micro environment that tend to shape up the market performance. Looking at one variable to decide on timing the investment can be futile and risking one’s financial goals. For investment professionals too, there is learning: Focus on the stock selection and structural portfolio strategies rather than the tactical trading bets.
Mid-Caps or Large Caps
Another question that is asked is, whether one should invest in midcap or large caps or a combination.
I visualize in the context of this question, an expert surfer who manages to ride huge waves perfectly which is not everyone’s cup of tea. In investments also, such an expertise to time a shift from large cap to mid-cap and vice versa, at the right time, for every cycle, may be very rare, may be more by chance. Markets are known to be irrational, at times overpricing / underpricing certain cohort for an extended period. Good news lies in the last 15 years performance of S& P BSE Sensex and S& P BSE Midcap (shown in the first part of Table 1 above). There is an insignificant difference in the returns delivered by these two capitalization indices over 15 years period considered here, although generally, Mid caps returns tend to be higher but so is the volatility in the returns.
Thus, staying disciplined about the allocation to equity and investing for a long period is important for reaching one’s financial goals. Within overall equity allocation, depending on one’s risk taking ability and willingness, the allocation to large cap and mid cap can be decided.
Which sectors to bet
The other favorite discussion around the election time is “which sectors will do well”?
The volatility at the sector level is usually very high, therefore sector indices may have much sharper movement when compared to the broad market indices.
Please refer to Table 2.
Typically the sectors which are perceived to have certain influence from the Government either in terms of pricing, environment regulations or in terms of capital spending have reacted very sharply on the first day after election results as investors’ expectations build up For e.g. Oil & Gas, Capital Goods and Realty. However, the performance after day 1 does not indicate any correlation with the strength of the Government and fortune of the sectors. In fact these sectors have underperformed the S& P BSE 100 over 10 and 5 years period. Not to suggest that these sectors are to be avoided as there may be a play of attractive valuation, improving business environment and favourable macro which may give opportunities in these sectors also, but just buying into or selling them out on the strength of the election results would be a case of oversimplification and overconfidence on one’s ability.
Consider the divergence in the performances of various sectors on day 1 and post that. Reacting based on the performance of day 1 can be very risky. Think of an investor selling the sectors which underperformed on day 1, to buy into the sectors outperforming on that day- he would have messed up his/her investment experiences over 6 months, 5 years and 10 years investment horizon. Investor would be better off avoiding such speculative tactical decisions or if not, he/ she can at least restrict betting to a very small proportion of the overall allocation to equity. Core allocation of one’s equity investment therefore should go into diversified strategies.
The investor returns depend not on how well he/ she forecasts the election outcome but on the entry valuation and the extent of future earnings growth outcome factored in that valuation.
Data Source : Bloomberg
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