If exit polls are right, reduce exposure to equity. - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
If exit polls are right, reduce exposure to equity. A  A  A
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14 MAY 2014

The media spends tens of crore on media equipment and star-status anchors, each with an army of research staff under them, to make a correct prediction on the outcome of the polls.
Yet, the media does not seem to get the opinion polls right.

Investors like you have given hundreds of crore in fees that have ended up in the coffers of the CEOs and CIOs of the Elite Mutual Funds - those who have stayed silent as you have been consistently buried alive by their collusion with distributors and banks; these same Elite CEOs and CIOs now expect to further benefit from the bizarre SEBI rule of insisting that an Asset Management Company must have a minimum net worth of Rs 50 crore before it can launch a mutual fund.
Yet, that hundreds of crore in fees paid have not really helped you participate in the returns of the stock market.

So add the ignorance of the media to the conniving ways of the Elite Mutual Find houses, sprinkle this with a Shining Stock Market and - lo and behold - what do you have? A potential recipe for disaster.

For those with memories that have been wiped clean by the success of the Gujarat Model, here are two graphs of the market movements after the 2004 and 2009 elections.

Graph 1: In May 2004, the incumbent BJP lost the election to the Congress-led coalition: stocks nose-dived by -20%

Source: Bloomberg:

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Graph 2: In May 2009, the incumbent Congress-led coalition did better than expected and stocks surged by +17.2% in 36 seconds of trading on May 18

Source: Bloomberg:

What happens next?
Now that the first exit polls have been released and have had ratings higher than either the return of Sachin Tendulkar to save the Mumbai Indians or the election of Modi to save the husband of the owner of the Mumbai Indians, the most important question - even more important than what will be the price of gas from the KG fields - is the overbearing Indian lament "but, what to do?"

Well, here are 3 scenarios and 3 potential outcomes:

  1. The exit polls are right and Modi and team will win over 320 seats: the market could:
    1. surge by another 10% in one day; so the S&P BSE-30 Index may cross 25,000,
    2. then there will be a pause to see who will be in the cabinet,
    3. then there will be a reaction to the new policies and budget which will be announced by the end of June,
    4. if the budget is good, then the Index may stay in the 25,000 to 27,000 range but if the budget or policies are seen to be like those crafted by President Pranab Mukherjee when he was Finance Minister in 2012, look for an Index closer to 18,000

  2. The exit polls are wrong and Modi and team win less than 250 seats; the market could:
    1. see the S&P BSE-30 Index plunge by 10% to 15% to the 18,000 to 20,000 range in one day,
    2. then there will be a pause to see who forms the government;
    3. if there is a Deve Gowda type Congress-supported government, the market will stay at 18,000 levels,
    4. then if the budget is poor, knock off another 10%; if the budget is good, then add 10% to maybe a 20,000 level for the S&P BSE-30 Index
What if it is Scenario 3?
So these above two scenarios are pretty clear and assume that the media, as has been proved in the past, know very little about what is really happening in India and the knowledge and information claimed by the media is derived largely from their town hall, people, and studio meetings they orchestrate to give an impression they really represent the views and news of India. Chai wallahs and taxi drivers - who earn 5% of what the media shakers earn, though free of tax - probably have a better pulse of India. George Fernandes and Narendra Modi are examples of that street pulse.

The third scenario - which is more troubling and complicated - is: what if the polls are correct?
What if the media really know their stuff?
And what if the CEOs and CIOs of the Elite Mutual Funds - and the Chairman of SEBI - are right in propagating the absurd idea that a mutual fund must have a minimum net worth of Rs 50 crore to qualify to fleece investors of their money?

The potential Scenario 3 was triggered by something I read on the web version of The Hindu Business Line which had compiled this summary table of the various polls released on the evening of Monday, May 12th:

Source: Hindu Business Line, May 12, 2014
AUTHOR'S NOTE: the last row of "2009 (Actual)" seems to have an error;
the "Others should be 122 - not 79 - to take the tally of all 3 columns to 543 seats.

The markets surged on Tuesday, focusing on the rout of the Congress and the victory of Modi. (Yes, Mr. Chidambaram, please accept that the stock markets really don't like you anymore and their rise since September has nothing to do with the quick fixes that you put in place, but are based on the hope - however wrong it may be - that Modi will turbocharge India.)

But, under this Scenario 3, India could be in some trouble pretty quick. Any celebration party should have well-marked signs for the exit door.

The problem with this Scenario 3 lies in the rise of the numbers in the extreme right column, innocently marked as "Others". Rather than an election result which focuses on national parties and their allies, voters are giving more strength and power to regional parties. Note that while the world is focusing on the left side of the table at the column marked "NDA (BJP+)" and while Modi may form a government and justify his premature "time for unity" speech, this column called "Others" can result in a repeat of what happened to Vajpayee's 13-day government. "Others" is estimated to see an increase in number of seats won by 20% to 40%. The country is not unifying under the 2 main parties, it is further fragmenting.

The Other Lady jilts the Macho Man.
So Scenario 3 is this:
  1. The exit polls are correct, Modi and his allies win 270 to 280 seats (they need 272 seats) and Modi comes to power, the market could
    1. first gain and then lose - to stay flat or marginally higher by the end of the day, say at the 23,000 levels
    2. while forming a cabinet, some large allies walk out OR while formulating the economic policy and budget, some large allies walk out OR Congress does a googly and convinces a large ally to leave the NDA camp and join them in a long holiday in some vineyard in Italy where they cook Jain pizzas, pastas, and idli-dosa; some large allies may also hate certain people who quote Sanskrit verses in budget speeches and - to eliminate these retired critics once and for all - those poet-Ministers are sacrificed by the Family in order to have a tough lady pull the rug under the wide-chested Modi,
    3. the S&P BSE-30 Index could plummet to the 18,000 / 20,000 range
    4. Modi tries to get some more people to join his Grand Coalition of the Willing to replace the large ally that has flown his cozy nest- but there is no large single group of seats under "Others" - he needs to woo too many parties;
    5. The government gets unwieldy, a man who is so used to doing what he wants to do now has a cacophony of voices drowning his dream; he can't take it; time to head back home to Gujarat; time to recall L K Advani, Jaswant Singh, and Murali Manohar Joshi to the senior positions in the Party;
    6. The large lady now becomes PM supported by a party run by another lady - and the member of the Opposition is another lady;
    7. The S&P BSE-30 Index tanks to the 16,000 to 18,000 range: the Woman's Rights Commission files a discriminatory notice against the stock market regulator, SEBI, for failing to insist that every AMC must not only have a net worth of Rs 50 crore but must also be run by a woman because a woman would never allow a sell-off of this kind in a country ruled by three women;
To these 3 possible scenarios, add the uncertainty of the monsoons and its impact on food prices and inflation. If inflation remains high, the RBI is not likely to reduce interest rates.

Spice this with the geo-politics of the China adventure in the South China Sea, the Russian march on Crimea and potentially other ex-Soviet regions, and the US now in lame duck mode as President Obama begins to write his memoirs.

Stir this recipe with economically weaker China, still weak Europe, confused Japan, and pools of money slowly deflating the Great Expansion of Central Bank balance sheets as the US and UK reduce the rate of printing new money. Clarification: they will still print, but at a reduced rate.
This lower rate of printing new money is traditionally not good for asset prices (stocks, bonds and real estate) in Emerging Markets, including India.

From the 23,000 levels where we are now the market has a chance to head to 25,000 or 27,000 if a few things go right.
Though it may have more of a chance to head to 18,000 to 20,000 - because so many things can go wrong?

A negative Indian (and/or global) environment will also weaken the Indian Rupee. The Foreign Institutional Investors have bought over USD 10 billion worth of stocks and bonds in the past few months.
That could unwind very quickly on any "disappointments" further adding pressure to stock markets. SEBI has failed to understand the problems of retail investors and the continued withdrawal of retail money from the stock markets leaves the BSE-30 Index vulnerable to foreign mood swings.

Trim, don't sell out completely!
No, this is not the time to be "overweight" in equities.
But do not sell out completely!
Over long periods of time - which includes the reign of incompetent governments run by the Congress and the BJP - the returns from investing in stock markets is one of the few ways to secure your financial future, to give you the wealth to buy a home, or plan for your retirement.

You must always have an exposure to stock markets because - like the media - we in the investment business are clueless on when markets can suddenly turn and neither do we know how high they can surge. So do not count on us to tell you when precisely to buy or sell.
How many of these guru fund managers who blame you, the much criticized "ordinary" retail investor, for not buying any shares; how many of them were out there buying shares in October 2008 or in August 2013? Or coming on TV and yelling "Buy Now!"?

While you do need to invest in stocks, be careful.
Within your exposure to stock markets, avoid companies with debt and managements that thrive off corrupt or questionable connections with governments and bureaucrats.
And avoid mutual funds that invest in these companies. Or limit your exposure to these "plays on the India story": control your greed.

The elections may be over.
The exit polls may be over.
And on May 16th the election results will be known.

As pointed out, there are still so many unknowns out there.
The stock markets are, in my opinion, ignoring these potential bumps and shaky bridges.

So trim some of your holdings, revamp your portfolio, stay away from companies with debt.
Don't go digging for oil and gas or fishing for spectrum.

And pray hard for the good health of the Reserve Bank of India: they may, yet again, have to guide India through a tough few quarters if some of these local or global scenarios turn ugly.
Like a patient caretaker, the RBI needs to clean up after the bad stuff left behind by the animals that populate the Indian political scene.
And, then you will have Scenario 4: an Index beyond 30,000. Don't get excited now - that is some time away. For now, be focused on the various forces shaping the next few months. Be careful.

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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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8 Responses to "If exit polls are right, reduce exposure to equity."

Nidige Kumar

May 14, 2014

Excellent Scenario Analysis. Ajit's Style.

Like 

D D Kochar

May 14, 2014

The entire article is like doomsday prediction except for a faint ray of light at end of a long-long tunnel. Just a six month wait may bring out whon is right/wrong.

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Rajesh

May 14, 2014

The only source of advice I have ever seen that is in genuine interest of Aam investor

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K Bhaskar

May 14, 2014

When can u come out of this 'pathological' mindset ? U r full of negativity and always attribute all the negative things to Modi. Seems u r a "khangressi" spokesperson. Then plz be honest and tell the world ur true colour. Just naming the article as 'honest truth' doesn't make a person honest

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SHARAD CHANDAK

May 14, 2014

I am sorry to say that, but it is a lengthy article without any substance. How the SEBI guidelines on minimum NW of AMCs and poll results are interconnected?

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UDAYA BHASKAR

May 14, 2014

GREAT article & great scenarios...Hats off for great insight.

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R.A.Srivastava

May 14, 2014

Really good advice. Clear, concise, to the point, and very logically explained. An advice by a wise man, I must say.

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RUPESH CHENDVANKAR

May 14, 2014

SIR BINGO ON THIS ARTICLE ,I AM A FAN OF YOURS AND HAVE DONE A LOT OF HOMEWORK ON CAPITAL MARKETS ALWAYS TRYING TO BRING COMPLEX SUBJECTS INTO A SIMPLE UNDERSTANDING, WITH MY READING AND ANALYSING HABIT HAVE CREATED CERTAIN STRATEGIES TO TRADE FOR LONG TERM WITH THE DURATION ABOVE 1YRS AND SHORT TERM BELOW 1 YEAR AND I WISH TO DISCUSS IT WITH YOU ,HOWEVER THANKS FOR YOUR TEAM THEY CONTACTED ME AND SAID THAT YOU ARE OUT OF COUNTRY FOR MOST OF THE TIME AND ITS HARD TO GET IN TOUCH WITH YOU .HOWEVER SIR WILL REALLY APPRECIATE IF YOU CAN REMOVW SOME TIME AND MEET ME AT YOUR OFFICE WHEN YOU COME TO INDIA .
REGARDS,

RUPESH R CHENDVANKAR (7303344482)

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