Stock markets, globally, have been surprising even the optimists. The bull run has taken even the market gurus by surprise. An important point of discussion in stock markets now is the excessive valuations in the markets and the possibility of a major market crash. Many market gurus have sounded warnings about the froth in the market. Highly respected voices like Ray Dalio, Michel Burry, Jeremy Grantham and Stanley Druckenmiller have warned that the current frothy valuations are unsustainable and, therefore, a crash is coming. In India, the RBI in its FY21 Annual Report warned about a stock market bubble.
There is a near consensus that valuations are excessive in most markets, developed or developing. This is explained in detail in the editorial.
Since valuations are excessive, this is not the time to aggressively invest in the market. While continuing with SIPs, investors may book some profits and rebalance portfolios by slowly increasing the allocation to fixed-income assets. However, in a bull market, it always makes sense to remain invested. Which are the safe sectors where investors can remain invested and even consider buying on declines?
IT is a safe bet
IT is a sector that gained from the pandemic. With digitization in fast forward mode all over the world, IT companies are reporting major deal wins. IT leaders in India have categorically stated that the industry is on the cusp of a multi-year expansion cycle. Of course, valuations are on the higher side: TCS, Infosys, Wipro and HCL Tech are trading at PE multiples of 39, 36, 30 and 29 respectively. But, earnings visibility will support valuations. More importantly, in the event of a market crash and capital outflows, the consequent INR depreciation will benefit the sector and, therefore, IT will be relatively resilient even during a sharp market correction.
Financials, particularly the leading private sector banks, have been underperformers in the recent rally. Poor credit growth and NPA concerns have become headwinds for the sector. But there is a clear trend of leading private sector banks increasing their market share at the expense of the PSU banks. Private banks’ share in loans has risen from 21.26 percent in 2015 to 36.04 percent in 2020.
Since the banking index has been underperforming and the valuations are not stretched, the leading private sector banks look good for investment. Also, the leading fintech company, the leading private mortgage lender and the leading private insurers – both life and general- look good for investment since they have many years of potential growth ahead.
Explosion in data consumption, thanks to the pandemic, has benefitted the telecom sector. This sector is now practically a duopoly and the two dominant firms are now in a commanding position to benefit from the imminent 5G revolution. A revision in tariffs, long due, will add substantially to the bottom line.
Health care and pharmaceuticals
The sector, which benefitted the most from the pandemic, is the pharma sector. The Covid shock has forced nations to focus more on health care.
India, being the pharmacy of the world with exports of $24.4 billion in FY 21, stands to benefit. Particularly companies with competence in CRAMS (Contract Research And Manufacturing Services) and leaders in API (Active Pharmaceutical Ingredients) are set for a long period of growth. Global pharma majors are now looking away from China to India and India’s core competence in this segment is strong. But, investors should remember that the pharma stocks with strong potential for sustained growth are priced to perfection. So, ‘buy on declines’ would be a good strategy. Apart from pharma, the specialty chemicals sector also is in a multi-year boom phase with demand shifting away from China to India.
Textiles and auto ancillaries
Apart from IT and pharma, two sectors that stand to gain from the ongoing export boom are textiles and auto ancillaries. INR depreciation – from 72.50 to the dollar in May to around 74.50 currently – is a boon for exporters. INR is likely to weaken further, going forward. The textile industry is showing a clear upturn in fortunes. In Q4 FY21, a sample of 122 listed textile companies registered an aggregated YoY rise of 27 percent in revenues and an impressive 123 percent rise in profit after tax. This trend is likely to accelerate going forward. India’s auto ancillary industry with distinct comparative cost advantages is all set to gain from the ongoing export boom. The tailwind from INR depreciation has the potential to boost the bottom line substantially.
Capital goods and real estate
An ideal portfolio should have a mix of defensives and cyclicals. The Capex cycle, which has been weak since the global financial crisis, is all set to stage a comeback. All ingredients for a multi-year Capex cycle are now in place. Government expenditure on infrastructure is a major driver of the economic expansion underway. Capital goods majors will gain from this. Real estate is another segment staging a strong comeback with the historically low home loan rates and stamp duty concessions in major markets acting as strong tailwinds. This bodes well for the cement and other construction-related segments like ceramics, paints, adhesives etc.
Nifty metal index has been the leader in the 2021 rally with returns of 62 percent vis-à-vis Nifty return of 14 percent YTD. Even after this big run up, the valuations of the sector are reasonable. It appears that the metal cycle, which has been depressed for long is now set for a long-term expansionary phase. The robust economic recovery in the US, China and Europe bodes well for metals like steel, zinc, aluminum and copper.
Mid-small-caps likely to outperform
In an expansionary phase of the business cycle, mid-small-caps normally outperform the large-caps. For instance, as on 7th July 2021 the 1-year return from the IT market leader TCS is 49 percent while the 1-year return from Persistent Systems is around 400 percent. This outperformance of the mid-small-caps can be substantial in the medium to long run. Also, in an expansionary economic cycle outperformers may be stock-specific, not sector-specific. But identifying potential mid-small-cap winners is not easy. Therefore, the ideal investment strategy would be to invest in the mid-small-cap space through mutual fund SIPs.
A good analysis