Mutual Funds

Does it pay to predict election outcomes?

Manish Gunwani | Updated on April 22, 2018 Published on April 22, 2018

Rather than guessing results, investors should identify other critical factors

Elections are considered to be the mega events for stock markets. Therefore, it’s not surprising that many pundits try to predict election outcomes much in advance.

But how practical is it to predict election outcomes, and more importantly, how useful is it as an exercise?

In June 2015, when Donald Trump formally announced his candidacy for the US presidential election, not many pundits reckoned he will become the 45th President of the US. Similarly, when the British opted for Brexit in the much-discussed referendum in 2016, it came as a nasty shock to most forecasters.

In India, too, there has been umpteen examples in the past couple of decades where general as well as State election outcomes have come as a nasty surprise to many.

Getting it right

Arguably, with the advent of big data, social media and other advanced technology, the accuracy of the predictions should have improved. However, recent examples in the US, Europe as well as India hint against that. Getting the election forecast right appears to have become more of an exception rather than the norm.

In India, in particular, given our diversity, predicting election outcomes are far more difficult. Yet, the noise regarding the 2019 general elections have already started, more than a year in advance. This is quickly becoming the single-most important point of discussion, particularly in the stock market.





Long-term effect

Even if we assume that there are pundits out there who can, and will, predict the accurate election outcome, the real question is how useful is this endeavour? For that, we need to check whether what we perceive to be a good or a bad election outcome for macro and markets, turns out to be so in the next five years.

Let’s look at these two prominent examples.

The 2004 general election outcome came as a major shock to financial markets since the NDA, led by AB Vajpayee, was widely expected to come back to power. When that failed to happen, the stock market fell by more than 20 per cent in a matter of days.

When the UPA came back to power in 2009, the markets gave a massive thumps up for the Congress’ comfortable victory.

What ensued for the subsequent five years was startling. Between 2004 and 2009, when the expectations from the UPA government were muted, India witnessed a period of fastest-ever per-capita growth as well as the biggest stock-market appreciation. Real GDP grew by over 8 per cent compound annual growth rate (CAGR) and Nifty delivered over 19 per cent CAGR returns during UPA I.

In contrast, when the same regime regained power with a greater majority, the subsequent five years were nowhere close.

If we analyse global examples, the findings are not much different. When Trump won the US presidential elections, market experts gave stern warnings against both the US and global economies and stock markets.

Since then, we have witnessed a synchronised global macro recovery, lowest volatility and the best stock-market returns in the post GFC (global financial crisis of 2008) era.

We can, therefore, conclude that it’s not easy to predict election outcomes. Further, it doesn’t reward much even if we are right about election outcomes. While elections are important, there are other factors which are equally critical.

Beyond elections

The first and foremost thing is continuity of economic policies — this should be maintained and/or improved under the new government.

One of the other key factors is the balance sheet situation of the various stakeholders of the economy. If the balance sheets of the government, the private sector, households and the financial sector are in good shape, economic expansion is bound to accelerate.

Global factors as well as liquidity environment and medium-term productivity gains also determine the fate of the markets.

Above all, for stock-market returns, what matters is earnings.

Other things being equal, whenever EPS (earnings per share) growth improves sustainably, the market tends to do well.

In essence, while governance, and in turn, policy-making are very important, the overall growth environment gets influenced by many other factors.

It’s heartening to see that much of the cleaning up of the economy seems to be over. Monsoons are likely to be good, and election-related spending should help spur domestic demand.

The definite economic uptrend should translate into solid broad-based earnings recovery over the next 12-24 months.

We acknowledge that volatility could be higher than in 2017, partly due to the cacophony related to the 2019 general elections and a few State elections in between.

But as discussed, it’s far more rewarding to identify the ‘sweet spots’ in the market rather than worrying about the elections and related best-educated guesses.

The author is CIO, Equity Investments, Reliance Mutual Fund.

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