Sector Show Swings with Economy and Street Expectations
The Indian stock market has rewarded long-term investors handsomely. The Nifty 50 has delivered close to 12%* pa returns over the last 20 years – significantly better than inflation as well as other traditional fixed return savings instruments. However, while the overall market performance has been great, under the hood there has been a significant variability among individual stocks and sectors.
The table below provides a summary of how broad sector allocation in the Nifty index has changed.
The difference in two periods is quite stark. Weightage of sectors such as oil & gas, power and telecom have come down whereas the share of financials, auto and consumer sectors has gone up substantially. It is almost as if the two readings represent two entirely different markets. A similar observation can be seen when one analyses at the stock level.
While it seems like there was a significant flux in the market over these nine years, in fact, this kind of churn is not unusual and will be seen if one takes other periods as well. The explanation lies in the state of the economy and the stock market’s expectations for the same.
In any economic cycle, there are winners and losers based on a number of factors such as the demand environment, competitive intensity, capital availability, global cycles, etc. Further, some sectors are inherently more cyclical in nature and tend to be more leveraged on the economy such as commodities and infrastructure sectors. The huge boom in the economy during 2003-07 allowed the cyclical sectors to prosper which led the stock market to reward companies from these sectors. As the market capitalisation of these companies soared, so did their weight in the benchmark indices. This is where the market got it wrong. As these sectors had delivered over multiple years, it became the market gospel that they would remain the themes that will deliver in the future as well. So, an inflated valuation was given on top of inflated margins – not factoring the cyclicality of the business models. However, while the stock market valuations can be irrational at certain points, over a longer period they do reflect fundamentals. As things played out, the turning of the cycle post the GFC and especially post-2010, have found infrastructure and commodity sectors struggling mainly due to slowing economic growth globally and domestically coupled with high debt levels. The stock market has caught up with the ground reality and the valuations have taken a hard knock – reflected in their sharply lower Nifty weights.
By contrast, certain other sectors have seen more secular growth stories. These include retail focused financials, consumers and autos – to name the three most prominent examples. While these companies also did well in the boom years, their growth got eclipsed by the cyclical sectors as far as the market impact was concerned. However, as the economy spluttered and these sectors continued to deliver, the market saw a sector rotation in favour of them – which is reflected in their current preeminence in the Nifty.
In effect, the market has rotated from capex-centric to consumercentric sectors.
INVESTMENT IMPLICATIONS OF THE SECTOR CHURN
So, how is the above, relevant from an investment perspective? Firstly, there are no permanent winners or losers. No theme – doesn’t matter how powerful it may seem at the time – can continue to run at a higher pace than the general market, especially once it becomes a meaningful part of the economy.
So, does that mean that the current market favourites – financials, consumers – represent some sort of risk or irrationality on the part of the market? The short answer is not right now, but if this trend persists to an unreasonable level not matched by the underlying fundamentals, it can happen. Ultimately markets are slaves to earnings. So long as earnings are delivered in those companies or sectors, the momentum would continue and the day earnings decline/ taper, the market would punish them.
The author is equity head at Axis Mutual Fund (Views expressed are personal)