With the Union Budget announcement approaching, many traders and investors are adjusting their strategies in anticipation of its impact. However, while it may seem logical to base strategies on predictive indicators, the stock market's inherent volatility means it often defies straightforward predictions. This lesson was starkly illustrated by past instances, such as election-based expectations and supposedly reliable indicators like polls, which proved to be speculative and unreliable.
Highlighting this unpredictability, a recent study conducted by a SEBI-registered portfolio manager emphasized the drawbacks of relying solely on short-term budget expectations. Instead, the study urged long-term investors to maintain their focus on fundamental analysis and strategic consistency, advocating for a steady course despite the transient effects of budget announcements.
Let’s dive deep into this thought and understand why the study argues on building a fundamentally valued portfolio rather than seeking short-term returns led by economic events.
Union Budgets: A Poor Predictor of Annual Returns
The study highlights that Union Budgets are a “poor predictors of annual returns,” suggesting that long-term investors should avoid making market decisions based on budget expectations or announcements. While budget days are marked by significant market volatility, these fluctuations are not reliable indicators of long-term market performance. The study finds that the underlying fundamentals of corporate earnings growth are what truly drive the markets over the long haul.
The Long-Term Perspective: Fundamentals Over Budget Announcements
For a long time, investors have been counselled to view their stock market investments as enduring partnerships. While economic events or policy changes can profoundly impact market volatility, they do not typically alter the fundamental essence of investments. The study suggests that while significant economic events may trigger short-term market fluctuations, the long-term trajectory is primarily influenced by the underlying fundamentals of corporate earnings growth.
The advice extends to caution against making substantial equity allocation decisions based solely on budget announcements. Instead, investors are encouraged to remain steadfast in their investment plans and financial goals, prioritizing a consistent approach despite the transient reactions of the market in the short term.
Examples of Market Reactions to Budget Announcements
The study provides compelling examples illustrating how markets have historically reacted to budget announcements, further emphasizing the unpredictability of such reactions:
On July 8, 2004, the UPA government made significant tax reforms by abolishing the Long-Term Capital Gains (LTCG) tax on equities and introducing the Securities Transaction Tax (STT). Although these changes were favorable for investors, the market reacted negatively, and the Nifty 500 dropped by 3.2% on the announcement day.
In February 2015, the NDA government announced a roadmap to reduce corporate tax to 25%, which was anticipated to boost corporate earnings. Nevertheless, the market’s response was tepid, with the Nifty500 rising only 0.4% on the announcement day. This initial optimism faded, and the index fell by 3.6% a month later, ultimately ending the year down 18.7%.
In 2018, the NDA government reintroduced a 10% Long-Term Capital Gains (LTCG) tax on annual gains exceeding ₹1 lakh. This announcement led to an immediate but minor drop of 0.1% in the Nifty500 on the day of the announcement. The market's reaction grew more pronounced over time, resulting in a 4.6% decline in the index a month later.
Other key observations reveal notable patterns in investor behaviour around Budget announcements. The best return on Budget day was recorded on February 1, 2021, with a 4.1% gain. Conversely, the worst return occurred on July 6, 2009, with a significant decline of 5.4%.
Investors tend to exhibit cautious behaviour leading up to the Budget announcement, reflected in negative median returns observed one month (-2.2%) and one week (-1.4%) before the announcement. This cautious approach aligns with a general trend where the investor behaviour mirrors one year prior and one year after the Budget, with reduced market exposure due to uncertainty 63% of the time. Once this uncertainty recedes post-Budget, investors typically re-enter the market 62% of the time.
Investing one day before the Budget announcement presents a "coin toss" probability of returns one month later, with a 54% chance of being negative. However, the odds of positive returns on a one-year timeframe align with the overall behaviour of the equity market.
Conclusion
For long-term investors, the study's findings are a stark reminder to avoid getting swayed by the ephemeral excitement or dread surrounding budget announcements. Instead, a steadfast focus on the fundamentals and adherence to well-crafted investment plans and financial goals is the prudent path to sustainable growth. Remember, the key to successful investing lies in the strength of the underlying fundamentals, not in the short-lived buzz of budget day.
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