Do Lok Sabha Elections Influence Stock Market Returns?

Do Lok Sabha Elections Influence Stock Market Returns? Does the market revive when a strong government assumes office? In June 2016, I had written an article titled, What drives the stock market: GDP? Earnings? Politics? RBI? I reproduce an extract from this article below due to the obvious topical relevance.

————–Begin Extract————–

Political Cycles as a market driver

Each time a strong govt has taken office, the market tends to revive for the next 3-4 years.

whilst over the entire 30-year period, the Sensex has delivered 16% (in CAGR terms), in this initial three-year window following these three critical elections, it has delivered ~33% (in CAGR terms)

Ambit Reseach report Nov 2014 (no longer available)

These cycles can create as well as destroy wealth. Therefore, it may not be a bad idea at all to rebalance a year or so before elections. With an election looming, if the financial goal is only a few years away, it makes sense (to me) to shift out of equity.

————–End Extract————–

Analysis

Five years after the above was published (the Ambit report), and just before the next elections, we can now ask how well the predictions fared. Sadly the report is no longer available at their site and I do not have an offline copy. So we will have to make do with what I had written previously and the above-linked livemint report.

They had predicted a revival in infra and banking sectors. The banking sector did revive (The Nifty Bank Index has more than doubled in the last 5Y). However Nifty Infra is struggling.

The other major observation is that 2/3rd of the positive returns have come in the first 3Y after the election.

If we look at Sensex annual returns above (screenshot from VR) both 2009 and 2014 were strong years but the circumstances were different. Also, strong returns of 2014 were absent in the next two years (in variance with the Ambit report). There are multiple reasons for this and the major ones do not involve demonetization or the GST. See: 2015–16 stock market selloff. Although it cannot be denied that demonetization did at the very least hold back the market a bit.

In 2009, the recovery was triggered by huge FII inflow. DId they come back because of the re-election of the UPA government (dubbed UPA-II) or because they had no choice? Impossible to say now, but at that time it would be hard to deny that a strong mandate did help.

In 2014, it was more preservation of the rally that started in mid-late 2013. Again possibly due to the strong mandate for the BJP.

So although clear cut patterns are hard to spot (because they are perhaps absent), it would be difficult to argue that the Lok Sabha elections have no effect on stock market returns. In 2014 I remember India Vix the volatility index shoot up around this time (rectangle below). Surprised to see it head lower since early Feb. Of course, this is only an approximate measure of the next 30-day volatility.

On the other hand, one could say that stock market influence is short-term. However, a couple of bad years is all that is necessary to influence the long-term sequence of returns.

What can investors do?

People worried about the elections should have the guts to lower equity exposure and take a call after results are announced at the cost of missing a possible rally or steer clear of a crash. I don’t think many of those who are worried would do this.

Those who use technical indicators for tactical asset allocation anyway need not worry about events such as these. Those who use goal-based asset allocation also need not worry about these events as long as they have reduced equity allocation well in advance before a goal. If you want money in 2024 and hold 100% equity, you are asking for trouble. Do not go by what AMC’s and many financial advisors suggest regarding equity exposure. They are clueless.

In conclusion, I think each election year is unique and as usual, the best answer with regard to how the market will respond, as always is,  I don’t know. So the only two options are:

• Ignore (if your goals are years away and stick to a plan). Have a strategy that does not depend on elections
• Act, reduce equity exposure significantly, especially if you need money “soon” (this could be 5-7 years). Have a strategy that involves lowering equity exposure prior to an election

As mentioned, the Lok Sabha elections and a new government’s decisions can influence short-term marker returns and these, in turn, do have a say in the long-term returns.

So, whichever option you choose from above, at the very least, consider rebalancing your portfolio (if necessary)

We have a unique situation where most stock investors are rather young and new to the market. So they are probably better off doing nothing except keep investing. Older investors with needs 5-7 away should probably play it safe and lower equity allocation.

Those in their 50s with retirement around the corner should also evaluate their strategy. If they do nothing, it is better to sit down and take stocks and ask what if the market crashes in May due to lack of a clear mandate?

An almost vertical movement (if seen zoomed out with past history) in the Sensex like yesterday (26 Mar 2019) over a few days can make everyone nervous.

It can come down as fast as it went up if no clear majority emerges. Remember the Karnataka polls? If a similar situation persists for a week, it will wipe out recent gains.

So again, if you are worried, do you have the guts to pull out an asset class on the rise (since late Oct 2019) without worrying about missing a rally or losing out to tax and exit load. If you do, then you have my respect. If you don’t then what is the point in worrying?

In every life we have some trouble
But when you worry you make it double
Don’t worry, be happy  – Bobby McFerrin

Whatever you choose, do not sit in cash and wait. That is of no use: Want to time the market? Then do it right! Buying on dips is not timing!

My position:  Currently my retirement corpus has about 58% equity (2% lower than desired) and my son’s education corpus has 62% equity( 2% more than desired). As of now, I am going to leave it as is. Whether it is a good move or not, only time will tell.

Check out the latest content from freefincal on Youtube