WHY DO ELECTIONS MAKE THE MARKET VOLATILE?

If you have been tracking the markets in the last few months, you could well have wondered whether you were on a roller coaster. In some ways, these last few months have been the poster boy to the statement that “Equity markets are volatile”. Today, the equity market has another E word associated quite closely with it, namely Elections. If you are still befuddled about the connection between these two Es – Equities and Elections then you are at the right place as today we explore why do Elections make the market volatile?  

Why do elections lead to volatility in markets?

Markets do not like uncertainty

If there is one adjective that summarizes the process of elections, it is most definitely uncertainty. Even when we are just about two months away from the result declaration for the general elections, no one can predict with any surety of what the new government may look like. Will the previous government come back? Will they be wiped by the opposition? Will it be a coalition? As a rule, markets do not like uncertainty. In the lead up to the elections, the speculative uncertainty just leads to them being skittish and swing either way in euphoria or depression depending on even the smallest bit of development.

Markets have a short term or near sighted vision

 There are two kinds of people who invest in equity markets – traders with short term view and investors with long term horizon. The markets are overwhelmingly made up of traders with a small percentage of investors. Even institutional investors like Mutual Fund managers have immense performance pressure making them give in to short term trading tendencies. When it comes to trading, short term or upcoming events have a lot to do with the momentum of the markets. Elections then become important in that short time frame.

FIIs make up their mind depending on governance 

FIIs or Foreign Institutional Investors at one time were a huge contributor and the Indian market swung wildly depending on their movements. While the dependency has reduced considering higher participation by Indian retail investors like you, FIIs still remain a force to reckon with. FIIs as institutions go, have a lot of options to invest and considering performance pressure are even shorter sighted. Elections are always keenly watched by FIIs as they make up their mind on the forecast of a country’s growth prediction for the next five years basis the result. Recently, since the skirmish with Pakistan, FIIs have come back with inflows into the market expecting a stable government back in power. 

Worry about over hauling of existing policies

The current government has been seen as bringing about quite a few structural changes and reforms like GST (Goods & Service Tax), RERA (Real Estate Regulatory Authority) and IBC (Insolvency and Bankruptcy Code) etc. Equity markets prefer the safety of a stable administration and status quo per se. If the current opposition comes to power or even if the current government comes back with a diluted mandate, markets fear that they might try and over haul some of the existing policies. This fear is another factor that some players in the market find worrisome.

 How should investors view elections?

While elections may keep the markets teetering on uncertainty, equity investing is ideally done with a long term view in mind. As an investor, you should look to 

Short term volatility over a longer period of investing 

When you go on a road trip, you might experience speed bumps or in India even potholes on the way. However, that is a momentary discomfort over the long distance and very soon you don’t even recall how many such disruptions you might have crossed. Elections is an event like a speed bump over a longer term investing horizon. Whether the market spikes or drops in reaction to the election result, it is bound to bounce back to normal over a period. Even when you look at some of the recent spikes, know that beyond some of the unnatural highs, the market will revert to normal.

Have a plan with goal based investing

Goal based investing is like a map for the road trip mentioned above. When you invest with a goal in mind, you are also well aware of the timeline at which you would really need the funds or the fork in the road that you would need to turn on. If the goal is atleast 3 years away, you have nothing to worry about as whatever the result, markets are known to normalize over a longer period of time. 

Be emotionally prepared for possible volatility in the next few months

Elections are an event whereby the market can only know how to react in extremes. If the opposition comes to power or worse a coalition or even a hung parliament, first reaction of the market is not very kind as chances of 5 year survival are dim plus there are lots of yin and yang energies at play in governance. In that situation, it could take some time for the markets to come out of its’ despondency. If, however, as is being widely anticipated, the current government comes back to power, the market is predicted to be euphoric as it expects stability and building further on work done in the last five years.

Stick to your plan

Most rational investors have an asset allocation for their investment goals. The elections are a great time to take stock of your portfolio, check how the asset allocation may have moved around and the steps that you then need to take to rebalance and revert to your asset allocation. Nothing else changes for the long term investor or his long term goals. 

Almost any election sees a five year cycle of wild swinging from the markets. As you get more experience of the markets, you will soon see it as par for the course and know that it’s a time to wait and watch for the cards to unfold. As for your investments, over the long term the returns are bound to average out and the performance bound to be as per earnings growth.