As US presidential elections have come close business news channels and pink newspapers are hysterically discussing scenarios for equity markets. Stock prices have been swinging based on the latest predictions.In fact as Donald Trump has gained in opinion polls in last week or so, Dow Jones in the US has been trending down.
Fear, greed but above all …excitement
We all hate uncertainty and the impending elections are creating fear understandably amongst investors. There will be some who will be waiting for some stock mispricing to appear post the election results so that they can tap the opportunity. Most of us are waiting with bated breath for the outcome. It is quite an obvious question – what should an investor in Indian equity markets do at this juncture?
One way is to take the problem head on. As the first step one needs to figure out how will the policies of the two main candidates Hillary Clinton and Donald Trump affect the markets.This should not be difficult as market strategists and economists have been generously commenting about various scenarios in detail. After that, what is left is to predict who is winning. Here too, agencies conducting opinion polls continue to publish their updated expectations. Finally position the portfolio as per the stated policies of the winning candidate. Simple ! Not really, as we shall see below.
Deep and wide top-down analysis may not always add much value
Selecting sectors and stocks, based on which candidate is wining and what are his/her policy statements does not sound difficult. Additionally it gives one the satisfaction that one is working hard to make money.
However this approach is difficult and futile due to three problems –
a) Forecasting the winner, especially in a seemingly closely fought election is never easy. History is replete with examples where opinion polls have gone horribly wrong – who can forget the opinion polls of Indian general elections in 2004 ?
b) It is not easy to predict the way the new president will act – just on the basis of his pre election claims and promises.It is not easy to guess what is going on in his/her mind.Then, where is the guarantee that the new president will stick to the stance that he/she has publicized so far. In any case over the next four years the president of United States will be fed so much new information that there may be sharp changes in his policy stance in future.
c) Finally, even if we are able to pinpoint the future policies accurately, how are we to predict the company performance and stock performance based on that. Aren’t there other, often more important, drivers behind the performance of a stock ?
Taper tantrums, Daesh, Rexit, Brexit
Let us also take an outside view – how has Indian stock market behaved after some hotly debated political or macroeconomic events in the past.
I) Taper tantrum – In May 2013 when the US fed announced that it was going to reduce its bond buying activity, even after giving ample guidance earlier, the markets – globally as well as in India, had taken a severe beating. BSE Sensex dropped by about 10 % through the coming 4-5 months. However it didn’t take too long for the markets to shrug off the impact of this event. By May,2014 the Sensex was up by 20% versus its May, 2013 levels. For someone with two years investment horizon, at least in hindsight, this event provided a good point to add to his stock positions.
II) Daesh – Early victories of Islamic State in the Middle East in 2H2014 had unnerved many market observers. In fact some commentators had started discussing possibilities of Indian army getting into a face off with IS in near future. The fears turned out to be exaggerated and IS success on the battlefield started fizzling out soon.
III) Rexit – In 1HCY2016 a public debate was raging regarding the need and likelihood of RBI’s then governor Raghuram Rajan getting a second term.There was absolute consensus that Governor Rajan had been doing a great job and a vast majority felt that he must be given an extension.
Most market participants were of the opinion that if he was not given an extension Indian market would nosedive and would see a sharp derating medium term.Media started discussing with amazing regularity,and some respected global newspapers published articles and op-eds highlighting,the potential damage that Raghuram Rajan’s exit would do to India’s image and to investments in India.
In June,2016 the governor dropped a bombshell by announcing that he would not seek a second term and would instead head back to his first love i.e academia. Many market observers, business news anchors and newspaper columnists were dismayed and aired their views highlighting the dent this would make on prospects of Indian equity markets. However in a matter of weeks (or rather, days) it became clear that markets were thinking otherwise. The impact was minimal and short lived.
IV) Brexit – This was another event which had been followed closely by investors in 1HCY2016. Opinion polls, TV interviews and newspaper columns kept people on tenterhooks. Finally when the British voted on 23rd June to exit the EU global, including Indian, markets were hammered for a couple of days.Surprisingly the impact was negated- soon.
Make no mistake, political or macroeconomic economic events do matter for markets.However all headline hogging events may not be so earth shattering as they seem initially.As investors we should avoid forecasting events that are almost impossible to forecast and where no amount of sincere hard work can give us an edge.
Active Inaction:Need of the hour
Now, a word about the type of investment psychology that is required for this. If we have investment horizon of 2-3 years or more, if we are not using borrowed money, and if we are not employing derivatives this inaction may save time and intensify our focus on more important aspects of investment process.
Conscious and well thought out inaction can at times be the best friend of a diligent, hardworking investor with time on his side.Perhaps Blaise Pascal was thinking of investments and markets when he had said “All men’s miseries derive from not being able to sit in a quiet room alone”.