Elections have a way of mixing up the market’s calculus. During elections, markets always try to second guess outcomes, check if there is something for everybody, and crave participation in a potential uptrend. Most people forget that sentiment driven rallies may end in a temporary downtrend. An adverse election verdict or one that is short of popular market sentiment could do the trick. So, election sentiments largely create rallies and trades which don’t last too long.
Over time, fundamentals take over and investment focus shifts to policy impact and global business response to the government’s moves. Yet, the investor community is obsessively focused on elections and we measure investment performance during elections with greater intensity. This has been the popular trend right from the onset of liberalization in 1991. Every election only sees more people betting their portfolios on politics. Speculative elements enter into investing during elections, smart money seeks to utilize the election trade to be nimble and to make it profitable. The important thing to remember is that this is purely a trade.
Let us jog our memory a bit and recall the 2014 elections. In the run-up to the elections, markets already sensed a change in government. Markets saw a clear alternative that was growing in national acceptance. Regular election surveys were showing growing public acceptance candidacy of Mr Modi. Despite that, our markets still lacked broad-based participation. More people were sitting on the fence awaiting election outcomes. Only willing and smart money bet early on the election change. By the time election results were out, markets had already rallied quite a bit and were definitely not looking cheap anymore.
However, the magnitude of the verdict sparked off a fresh post-election rally in the indices. Investment flows were strong based on expectations of reforms and progress. The markets went way ahead of fundamentals. Subsequently, for two years, the business performance of index companies lagged. The indices began underperforming and monies shifted wherever performance showed up. So, defensives and mid caps were significantly re-rated in 2017.
Anything in excess will always revert to mean, 2018 saw valuations contract sharply. In the past few weeks, pessimism may have formed a bottom and markets are gradually warming up to the election trade. Investors who had a good run in 2017 and 2018 have largely built portfolios to an older market context. The return of confidence has seen these portfolios recover from the recent lows. But the real trade seems to be elsewhere.
FIIs, DIIs, large operators, and HNIs are always serious players in election trades. Retail is always a follower and late entrant. Early trends show that FIIs may come back in a big way and their investments are largely within the indices. DIIs are mostly responding to flows, lightening a bit, and still betting on recent favourites like midcaps. The operators and HNIs are visibly warming up to election trade and seem to be expecting a sharp index spike if the election declares a clear majority.
This only means that the market calculus is going to be rewritten for the election trade. Liquidity will drive indices higher, this may not necessarily trickle down into the broader market. Whatever trickles down will seek visibly undervalued newer parts of the markets for a quick trade. Clearly, this is trading season. A lull may set in on some parts of the market while indices keep rising. Or, if market sentiment takes wings, all boats may rise. But that is still a tall ask, as business performance may not support a sharp rise in the market. Investing now should be based on sustainable performance.
