A good might not be good enough

Waiting for exams results was always a nerve racking experience for me, given the little amount of time I spent studying, so when I scored a first class in my SSC results my parents were over the moon, they were hoping I would just pass my exams. My friend Aditya despite scoring 85% was sad. On enquiring as to the reason for the same, he said his parents were expecting him to score at least a 90% in the exams. 85% was just not good enough. That day I learnt an important lesson, it’s not your actual performance that matters but the expectations against which your performance is measured which will decide whether you have outperformed or underperformed.

Let’s look at elections and equity market performance against this very same framework. I believe that election results should not affect your long term investments. To state this point, in 2004, UPA I came to power with a significant number of seats for the Communist Party of India. The markets immediately corrected by 22% (between 6th May 2004 - 17th May 2004) anticipating destructive economic policies which would damage the India story. The market correction set a very low benchmark for expectations of company earnings growth over the next five years. The next five years ended up being the golden era for the Indian stock markets. The S&P BSE Sensex gave a CAGR return of 22% (17th May 2004 - 14th May 2009). Even though a significant portion of the rally was aided by a synchronized global bull run, it would still be safe to assume that the Indian equity markets would have given positive returns even in case of a stagnant global market simply because the expectations set after the 2004 election results was so low.

In 2009 elections, the UPA government got a stronger mandate, with the CPI (M) losing a significant portion of their seats. Anticipating that stronger government without the hindrance of the left would be able to implement key reforms the markets rose by 28% within a span of one month (14th May 2009 -10th June 2009). Over the next four years (10th June 2009 -21ST August 2013) the markets gave a return of just under 4% from those levels as UPA II went into a policy freeze after a series of corruption scandals. Even if UPA II had been able to deliver on some economic policies, one can assume market returns would have been muted simply because post the spectacular rally just after 2009 election result, the benchmark set for corporate performance was very high (like in the case of my friend Aditya even 85% was not good enough).

Let’s look at current state of equity markets; we have had a spectacular 35% rally in the S&P BSE Sensex since August 21, 2013 till May 16 2014, the day of election results, in anticipation of a change in government, as early exit polls started predicting a loss for UPA. Post the strong showing of BJP in the elections, the rally has continued albeit at a significantly modest pace. However, reported earnings of Indian companies continue to remain weak, hence a significant portion of the rally is in expectations of possible reforms launched by the new NDA government which would substantially increase earnings of Indian companies over the next few years. Only time will tell, whether the NDA government actually delivers and exceeds expectations in terms of policy making and whether equity markets actually deliver superior returns from current levels over the next five years. However we know that with each passing day and with every increase in the equity markets, the bar of expectations is being set at a level which may be difficult to outperform.

In these uncertain times, investors should have a mix of assets like equities, debt and gold in their portfolio as effective asset allocation will help you achieve your financial goals in the long run.

Remember, you cannot take investment calls by just not betting on the election outcome. However, you should also consult a financial advisor before selecting any tool for investments.

Data Source: Bloomberg

Above article is authored by Quantum.

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