Sensex could turn negative post election results; here’s the strategy you can deploy

General elections are usually an important influencer of short-term returns from Indian equities and FII flows into the markets. The flows prior to the elections are obviously influenced by the expectations of the outcome, suggest experts.

The S&P BSE Sensex has rallied about 8 percent so far in 2019, in the run-up to the general elections, largely in line with how markets behaved in the last 20 years in the election year.

Historical data for general elections in the past 20 years suggest that Sensex gave positive returns in 3 out of last 4 election years prior to the elections. While half the times the index gave negative returns after the result announcement. This suggests that investors preferred to book profits once the event is out of the way.

“The last three out of four general elections have seen strong pre-poll rallies. In those years, benchmark indices have rallied more than 10 percent on average in the two months before the general election,” Vipin Khare, Director- Research, William O’Neil India told Moneycontrol.

Relative returns from the market also mirror this “expectation vs reality” syndrome. The 1999 and 2004 elections are at opposite ends of the spectrum in this regard.

“India’s pre-election underperformance was reversed by NDA’s victory in 1999, and the pre-election outperformance gave way to post-election underperformance due to NDA’s loss in 2004,” BNP Paribas said in a report.

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NSo what will happen in 2019?

Indian market hit a record high both in Sensex as well as Nifty and there is a likelihood of a repeat of 2014 when markets rallied in anticipation of a Modi-led government and then the rally witnessed profit booking at higher levels.

Sometimes, pre-election euphoria results in post-election indifferent performance even if the outcomes turn out to be expected. The year 2014 was a notable example.

“The expectation of BJP’s victory under PM Modi led to sharp pre-election outperformance of India – but “sell on news” kicked in after the election and the outperformance petered out even though Modi-led BJP came to power,” added the BNP report.

The recent rally which we witnessed in March was largely driven by foreign money entering markets. In absolute terms, FIIs have poured in more than Rs 47000 crore in Indian markets in the run-up to election or so far in 2019.

General elections are usually an important influencer of short-term returns from Indian equities and FII flows into the markets. The flows prior to the elections are obviously influenced by the expectations of the outcome, suggest experts.

“The expectation of a “market-friendly” government leads to FIIs’ preference for India over other Asian markets. If such expectations are met, as was the case in 2014, FII euphoria continues for 1-2 months and usually begins to fade by the third month after election results,” BNP Paribas said in a report.

“The year 2004 was an example of the opposite outcome. In anticipation of an NDA victory, FIIs bought India and sold rest of Asia prior to the elections. NDA’s loss in the elections punctured the balloon of hope – leading to a selldown of the Indian market. Even when flows recovered about 3 months after election results, India’s share of flows was minuscule compared to the rest of Asia,” it said.

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What should be the strategy now?

Volatility is the name of the game when it comes to major events like general elections. Indian equities would be no different than the global pattern of increase in volatility pre and post the major election results.

How do we reap benefits from such a scenario?

IIFL recommends an ‘A Long Iron Butterfly Spread’ which can be implemented when a trader is expecting higher volatility in the underlying assets.

This strategy is initiated to capture the movement outside the wings of options at expiration. It is a limited risk and a limited reward strategy.

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