ARE MARKETS AND ELECTIONS CORRELATED SIGNIFICANTLY OR SENTIMENTALLY? - Anirudh Madhusudhanan

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On 4th December 2023, the NIFTY 50 Index opened 300+ points above the previous close and closed 2.07% above the previous day, a move not seen in a long time. This violent rally was majorly fueled by the BJP’s victory in three of the four Assembly elections, boosting market sentiments. These results have raised optimism among the investor community that the incumbent party will be re-elected at the Centre in the 2024 Lok Sabha Elections, resulting in policy continuity and long-term growth.


Such a rally is not a one-off event witnessed in the Indian markets. In the 2014 General Elections, when the Narendra Modi-led BJP won in a landmark victory(successfully ending Congress regime), the stock market reacted positively as the victory was seen as a sign of political stability and the emergence of pro-business policies. A similar momentum was seen in 2019 when the BJP was re-elected to power.

WHAT DOES HISTORY TELL US?
Data suggests that in the year preceding a presidential election, both the equities and bond markets tend to perform more subduedly than in previous periods. This pattern may be seen regardless of which political party is in power. Following an election, stock market returns are often significantly lower in the following year, with bonds frequently exceedingly marginal. Notably, the influence on the stock market can differ depending on whether a new party takes office or whether the current party maintains control. In the US, it was witnessed that when a new party takes office, the average stock market gain is approximately 5%, however, when the same president is re-elected or one party holds control of the White House, the returns are somewhat greater, at around 6.5%.

DO POLITICS AFFECT THE MARKET, OR VICE VERSA?

In addition to election cycles, market performance is influenced by a wide range of factors such as interest rates, corporate profits, investor confidence, business cycles, trade policy, inflation, GDP, globalization, and global events. Because of these multiple influencers, it can be challenging to isolate the specific impact of political events on market trends. In fact, it might be more accurate to consider the possibility that the state of the market can influence election outcomes. For example, since 1928 in the US, when the market experienced gains in the three months leading up to an election, the incumbent party won the White House 12 out of 14 times

IS IT CORRELATION OR CAUSATION?

Market trends are not solely determined by election outcomes. They result from a complex mix of factors including investor sentiment, economic policies, and global events. While major political events can influence investor sentiment, focusing only on election results to predict market behavior is overly simplistic. Markets respond to the perceived impact of policies on business prospects, regardless of whether the incumbent party remains or a new leader emerges, as seen in the U.S. and the 2014 Indian elections. Ultimately, it's the perception of policy effectiveness, not just election outcomes, that drives market movements, making markets and elections sentimentally, but not directly, correlated.

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