What's Your Investment Strategy for General Elections 2019? - The 5 Minute WrapUp by Equitymaster
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What's Your Investment Strategy for General Elections 2019?

Dec 17, 2018

Ankit Shah, Research analyst

In a previous editorial, I'd take you on a quick journey through the stock market swings of 2018, and the key macro factors causing them.

Today, we'll set our gaze on the future.

In two weeks, 2018 will end and we'll be heading into 2019.

How will 2019 be for Indian investors? Will it be as turbulent as 2018? Or will it be smooth sailing?

The Biggest Event in 2019

From an Indian perspective, the biggest event in 2019 is the Lok Sabha elections. The polls are expected to start in April, and by mid-May we'll know who will form the next government at the Centre.

So, expect the political climate to tense up in the march up to the elections.

The debates will get louder and nastier. There will be a lot of mud-slinging.

Both the two major national parties BJP and Congress will make big promises. Socialism may take a front seat as various schemes, waivers, and freebies are announced.

The mainstream media will go overboard depicting and dissecting every piece of political drama and gossip.

And to satiate people's curiosity, you will soon find a barrage of predictions in the mainstream media telling you what to expect et al. It may almost appear as if the elections are the one and only factor influencing the direction of the markets.

I'm not saying that elections are inconsequential events. They do have some bearing on the mood of the markets, at least for the near term. But the sheer amount of mental space they occupy in the context of the stock markets is certainly exaggerated.

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So, my very first advice to you is to not take the media hype around elections too seriously.

That said, you may still have some of your own theories about how the markets will react depending on who wins.

For instance, market participants believe that currently the markets are factoring in a BJP win in the 2019 general elections.

What will happen if this assumption begins to develop cracks in the coming months? And what if the BJP loses the elections? Will it cause turbulence in the Indian markets?

Dalal Street logic says yes.

But before you buy these simplistic theories, let me share a couple of instances when the markets got it all wrong...

The Time When Wall Street Got It All Wrong

When President Donald Trump was contesting the elections in 2016, the mainstream view was that if he becomes President of the United States, the stock markets will crash and the US economy will slide into a recession.

For many investors, Donald Trump symbolised widespread fear, uncertainty, even madness... the very elements that stock markets hate. So, back then it did seem logical... in theory at least... that Trump's election would lead to a flight of capital out of the US. The US stock markets should have crashed the very day Trump's surprise win was made known.

In fact, some of the largest investment banks and hedge funds expected the markets to correct if Trump won.

Billionaire hedge fund investor George Soros too believed in this theory and made a huge bet on a stock market crash. He thought the markets would agree with him the way they had in 1992 when he went short on the British pound and earned US$1 billion in a single day, for which he is remembered as 'the man who broke the Bank of England'.

But his prediction that the markets would crash if Trump won turned out to be a disaster and cost him nearly US$ 1 billion.

What more, since Trump took office, the US stock markets have been in a bull market. The US economy has grown at a solid rate. And the US dollar has gone from strength to strength.

Now, I'm not saying George Soros is a fool...that he shouldn't have made the bet. He's a shrewd top-down speculator who's got many macro calls right. He's built a fortune betting on big events. But the Trump rally and Soros' consequent billion-dollar loss shows that even people who have been so spectacularly right have their own blind spots that can lead to disastrous investment results.

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Markets Shrug Off BJP Loss in State Elections and Dr Urjit Patel's Resignation

Let me offer you a more recent example.

On Friday, 7 December 2018, the exit poll results for the five state assembly elections - Rajasthan, Madhya Pradesh, Chhattisgarh, Mizoram, and Telangana - had predicted a bleak scenario for the BJP.

This caused a sharp sell-off in the markets on Monday, 10 December 2018. The Sensex lost more than 700 points.

Later that evening, news of RBI governor Dr Urjit Patel's resignation created panic on the social media.

A likely poor outcome for the BJP in the state assembly elections and the sudden resignation of the RBI governor were enough catalysts for another big round of sell-off in the stock markets.

The next day (11 December), the markets did witness a gap-down opening. But soon enough, the markets shrugged the bad news, started making their way higher, and closed the trading session in the green.

By Friday, 14 December, the Sensex not only reclaimed the losses witnessed at the start of the week, but went on to close above the levels before the exit poll results came out.

So, all the hoopla for nothing? Seems so.

How Should You Play the Markets in an Election Year?

The truth is that the future is unknowable. There will always be uncertainties. And markets hate uncertainties. So, they tend to always overreact to uncertainties.

The reason I strongly believe in the value investing philosophy is that it understands these fundamental truths about the stock market.

When you prefer to buy stocks at a margin of safety, you're effectively factoring in the possibility of negative uncertainties.

With the general elections approaching in a few months, there could be heightened volatility in the markets.

The best way to go about your investment strategy in an election year is to embrace uncertainty. Instead of getting overwhelmed by it, use it as an opportunity to build a solid portfolio of quality stocks when the prices are attractive.

Chart of the Day

On Friday, the Sensex closed at 35,965, just a little shy of the 36,000 mark.

Incidentally, the Sensex closed at almost the same level - 35,963 to be precise - at the end of January 2018.

But are the broader markets also back to the levels they were in January 2018?

To find out, I looked at the total market capitalisation of all the listed companies on the BSE.

The 10-Trillion Rupee Gap Between the Sensex and the Broader Markets

Here's what I found out...

The total equity market capitalisation of the BSE-listed companies was Rs 153 trillion at the end of January 2018.

The market capitalisation dropped over the next few months as the markets slid into correction mode. This was a time when small and mid-cap stocks were the worst hit.

However, the total market capitalisation went on to hit an all-time high of Rs 159 trillion in August 2018. This was driven mainly by the index heavyweight stocks. The broader markets hadn't quite recovered.

Eventually, the markets witnessed a major correction through September and October. The Indian markets closed the month of October with a total market capitalisation of Rs 138 trillion. In two months, the markets had lost Rs 21 trillion in market capitalisation.

There has been some recovery since then. However, the total market capitalisation is still Rs 10 trillion lower than January 2018.

So, while the Sensex is back to where it was at the end of January, the broader markets are yet to recover.

Happy Investing,

Ankit Shah
Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

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