Don’t Invest Based On Events

If there’s one thing that’s enamoured retail equity investors since the very advent of the stock markets, it’s investing based on events – or ‘trading the news’ in other words. Policy outcomes, global events, rate cuts, budgetary announcements and most recently – election outcomes – all become pivotal events in the minds of investors, around which investment decisions evolve. Here’s the funny part, though – it’s an exercise in futility.

Here’s a ‘for dummies’ explanation of why this approach almost never works. Stock markets are essentially teeming with millions of participants, most of whom are short term players (in other words, scalpers who are in to make a quick buck). In the short term, it is the buying and selling action of these traders that move markets up or down. As we lead up to any event, a consensus begins to form about the outcome of that event, that in turn drives market participants to either collectively turn bullish or bearish. In other words, consensus drives prices up or down before the actual event – which means that the most probable outcome is already ‘priced into’ the market at the time that the event occurs. After the event passes, these traders who got in begin to unwind their long or short positions as their work is essentially done – and this often pushes stock prices in the opposite direction. In the one-off case that the event outcome differs from the consensus, the event outcome does indeed lead to massive price swings in the direction opposite to the precluding build up. For instance, it’s safe to say that the broad market was already pricing in an NDA win as we entered the month of May (NIFTY: 11,700 odd) because once the results were actually announced, markets gyrated wildly but eventually settled at the same levels (11,700 odd)! Now, had the UPA effected a surprise win, markets would have tumbled and the contrarian short sellers would have made a killing – but such outcomes are extremely rare and also require some serious guts to trade – something most retail investors lack.

Spare a moment for the poor retail investor who sat on the side-lines waiting for the election results yesterday. At first, they would have experienced a desperate FOMO (Fear of Missing Out) as the bellwether NIFTY soared past the 12,000-mark intraday. Jumping in at that stage, they would now be sitting on losses as the index is down below 11,700 as I write this. This cycle goes on and on. Trade, lose, repeat. 

Now, with Modi 2.0 commencing, is all hunky dory? Time to rush in hook, line and sinker? I dare say not. The NIFTY trades at trailing PE ratio of 29, meaning that blue chips are far from cheap. The economic engine has been slowing for some time now. Consumption is dwindling, liquidity is low ad interest rates are high. Real estate continues to be in a slump. The re-elected government faces a herculean challenge in stirring up the juggernaut that is the Indian economy. And while there has been a significant correction of late in certain pockets such as small & mid-caps, and sectors such as pharmaceuticals, it’s safe to say that a “spray and pray” strategy such as blindly investing lump sums into blue chip stocks or funds simply because “the NDA government won yesterday”, will be yet another mistake that many retail investors will make. Here’s a tip – keep your cool and follow a disciplined asset allocation strategy. Stagger your equity investments using 3-6-month STP’s (Systematic Transfer Plans) if you’re a Mutual Fund investor. But whatever you do, don’t invest into equities just because the Modi government won yesterday. There’s a long and arduous journey ahead for the government to turn things around.