Assembly elections and market movements

When you toss a coin, the known outcome; it could be either heads or tails. The logic holds well when you look at investing in stock markets – you could gain or lose. The known outcome with stock markets before and at the time of elections is that they start behaving in a pattern which turns volatile. The 2014 general elections was a classic case when pundits predicating the outcome had to bite the dust and the BJP came to power with a thumping majority. The stakes are high as we get into state election results today, where the outcome in UP holds immense interest. The stock markets had gone up then and they are up now.

While watching the exit polls and the reaction of political commentators, party spokesmen and senior journalists on TV, I was reminded of brilliant American psephologist Nate Silver’s book “The Signal and the Noise: Why So Many Predictions Fail - But Some Don't”. Silver built an innovative system for predicting baseball performance, predicted the 2008 election within a hair’s breadth, and became a national sensation as a blogger. But a few months ago, his prediction of the US elections was not the way it finally turned out to be. If you have not read this book, it will make for an interesting read. 

Hard choice

By Silver’s own observation, the most accurate forecasters tend to have a superior command of probability, and they tend to be both humble and hardworking. They distinguish the predictable from the unpredictable, and they notice a thousand little details that lead them closer to the truth. Because of their appreciation of probability, they can distinguish the signal from the noise. The same is true when it comes to predicting stock market movements. On elections, the Americans have it easy to predict because of their two majority parties in the fray, whereas in India, the number of candidates for a seat can put at times kindergarten admission seekers in Delhi to shame. 

Take for instance Varanasi Cantt in UP, where a total of 24 candidates are in the fray for this single seat. Just imagine the EVM and the complex situation which a voter would have to undergo before being able to make the right choice. Stock markets are no different – there are about 5,000 odd listed companies with about 1,000 – 1,500 of them being actively traded on the bourses. Investors, analysts and traders are all looking for a winner of their choice from this set. Unlike elections where there is a single winner, in case of investments, one could have several winners depending on what an investor defines as the winning criteria.

Trend spotting

My discomfort with exit polls is that none of those who come out with the exit poll reveal the sampling patterns, the questions asked and their order, the assumptions made in converting vote-share to number seats, and other crucial details. To add to the problems, Indian elections often see seats being won by extremely narrow margins, which are less than the inherent error margins of any opinion poll. In the 2004 Karnataka Assembly elections, in Santhemarahalli Assembly, the winning margin was only one vote.

Given all these facts, betting on Indian election outcome with any high degree of confidence, is extremely difficult. It is the same when it comes to selecting a winning stock. Here is my prediction, with some trepidation – the stock markets will remain favourable and not crash post the results today. That the markets are closed for the next few days is a good strategy to not overly link market movements to election results. Yes, punters play the game, but that is for a different reason.

If you are an investor, you are clear about your investment time frame and objective, which is what you should stick to. One way out is to invest in mutual funds and stay invested over the long run, the experts managing the fund know what to do with money and remove the uncertainty from investing as they invest with a defined benchmark to track. Individuals are fallible and prone to use the wrong base and then course those predicting stock market outcomes.

nk@outlookindia.com