Elections And Investments: Is It Complicated?

Success in investing is derived from what you do not do. It is more about eliminating noise and finding reasons to ‘not act’ out of impulse. It pays to define your degrees of freedom and put a disciplinary boundary around your decision making. With a deluge of news, views and noise, investors are coerced into ‘taking action’ or churning their portfolios over by buying and selling on half cooked analysis, unimportant views and sometimes reverse causality.

Reverse Causality

For instance, Europeans in the middle ages thought lice were beneficial to your health – as there would rarely be any lice on sick people. And it was believed that people got sick because the lice left.

The real reason however is that, lice are extremely sensitive to body temperature. A small increase of body temperature, such as in a fever, will make the lice look for another host. The medical thermometer had not yet been invented, so this increase in temperature was rarely noticed. Noticeable symptoms came later, giving the impression that the lice left before the person got sick.

General elections are just a few weeks away. It makes a very strong case for investors to study and harp upon what can go wrong or right with their investments, basis the elections. While a complete post-mortem of election seasons Nifty returns and markets valuations are floating around in abundance. It highlights how that Nifty has returned nearly 45% in years in which last 4 general elections were held, it pays to go a little deeper.

In each of the last four general elections, there were massive macroeconomic changes.

• For instance in 2014, India was coming out of a long period of twin deficit problem and high inflation and in 2009, Indian problem emanated from the great financial crisis.
• Even in the prior two elections - drought and realignment of markets after Asian financial crisis played a major role.

Both these aspects indicate that more than elections, the important points to probe are; whether the stock markets are cheap or expensive and whether the bonds and currency markets are aligned to support a rally. Identifying this makes more sense than deriving the one or the other variation of historical returns. Returns, after all could be the lice scouting for a healthier economy-body.

The upshot is that, over the last year and a half, Indian stock and bonds markets have gone through a period of churn and are trading at valuations which appear attractive. Adding to this, the possibility that economic activity is already slow and probably near a typical trough in its cycle. This means irrespective of the results of general elections or the volatility corresponding to it the markets, are likely to look up by the time we reach end of the year.

Economic Policy Is Hard To Reset

Now this completely dismisses the thought that the political economy is important. After all, the government makes the policies which will impact the way an economy functions. But if you look closely, the economic policy seems to be in a preset mode, with very little difference between how different governments want to run the economy.

The focus is always to spur growth, act prudently on expenditure, reduce regulations to optimum levels and introduce reforms to support this framework. In fact, most of the India’s major reforms will be equally distributed across various governments of different political parties, whether majority or coalitions. The bottom-line is economic policy is hard to reverse or tamper with materially.

In conclusion, focus on earnings and valuations and stick to your game plan. As I mentioned in the example lice-scouting, determine whether the cause-effect theory is in place. Most importantly, refrain from confusing short-term volatility with long-term trends.