Sec­tor Show Swings with Econ­omy and Street Ex­pec­ta­tions

The Economic Times - - Markets: Beating Volatility - JINESH GOPANI

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)

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