Union Budgets Poor Predictors Of Annual Equity Returns, Reveals A Capitalmind Study

Market behaviour one week before and one week after budgets are interesting mirror-images of each other as investors seem to reduce exposure due to uncertainty up to budget day, negative 63% of the time, followed by re-entering once the uncertainty recedes after the event, positive 62% of the time.

Kolkata: Investors seem to reduce exposure one week before and re-enter one week after the budget day and investment made on the day before the budget has a 54% probability of returns after one month to be negative, according to a study conducted by Capitalmind Financial Services, a Sebi-registered portfolio manager.

The study said that Union Budgets are poor predictors of annual returns; long-term investors should be driven by the underlying fundamentals of corporate earnings growth.

The best return on the budget day was observed at 4.1% on February 1, 2021, and the worst return was recorded at -5.4% on July 6, 2009. Negative median one-month and one-week prior returns of -2.2% and -1.4% respectively indicate watchful behaviour leading up to the announcement. The returns one year prior and one year after are symmetrical

Market behaviour one week before and one week after budgets are interesting mirror-images of each other as investors seem to reduce exposure due to uncertainty up to budget day, negative 63% of the time, followed by re-entering once the uncertainty recedes after the event, positive 62% of the time.

However, if one invests on the day before the budget, returns one month later indicate a coin toss, with a 54% probability of being negative. Once you increase the time horizon the odds of positive returns on the one-year time frames are consistent with the overall equity market behaviour, i.e; positive in 2-3 of any 4 years, the study adds.

Anoop Vijaykumar, Investments & Head of Research, Capitalmind, said, “What our study implies is that while there tends to be significant volatility leading up to and immediately after the budget based on expectations, the longer term is driven by the underlying fundamentals of corporate earnings growth. Long-term investors should avoid making significant equity allocation decisions based on expectations or announcements made in the budget. Instead, they’d be better served by staying the course with their investment plans, keeping their financial goals in mind.”

Capitalmind study cited that Union Budgets are a poor prediction of annual returns and has explained the inference through four unintuitive examples of how markets reacted to budget announcements:

• In the 2003 Union Budget, the NDA government prioritised reducing the deficit by introducing new taxes, including state-level VAT and service tax. The CNX500, the broad market index of the top 500 companies in India, ended the day up 0.5%. A month later, the index was down 6%. A year later, the market had doubled.

• On July 8, 2004, in the first budget presentation of the UPA I government, Finance Minister P Chidambaram announced the abolishment of the Long-Term Capital Gain tax on equities and the introduction of Securities Transaction Tax (STT). All gains from holding stocks and equity mutual funds longer than a year would be exempt from tax, a significant plus for investors. The CNX500 fell 3.2% that day.

• In the 2015-16 budget, Finance Minister Arun Jaitley announced a four-year roadmap to reduce the corporate tax rate to 25%, a direct boost to company earnings and therefore potential shareholder returns. The CNX500 ended the day marginally up 0.4%. A month later, the market was down 3.6%; a year later, it was down 18.7%.

• Nearly 14 years after LTCG was removed, on February 1, 2018, NDA Finance Minister Arun Jaitley re-introduced a 10% Long-Term Capital Gain Tax on gains over Rs 1 lakh annually. The CNX500 ended the day barely unchanged, 0.1% down. The index was down 4.6% a month later, roughly where it ended a year later, first rising, then falling dramatically before partially recovering.