make sure you don’t end up with bad stocks from good sectors

Sectors to bet on in a polarized market

With polarization likely to continue for some more time, make sure you don’t end up with bad stocks from good sectors

    Long-time investors are probably experiencing déjà vu right now. For, the current polarisation in the market has clear shades of the situation during the 1999-2000 rally. It is polarisation that is worrying the market experts, not overvaluation.
    Currently, two types of polarisations are taking place simultaneously. One is on a segmental basis because scared investors are dumping small- and mid-cap stocks and rushing to the safety of largecaps. This explains why the broader market is in the doldrums even though benchmark indices like the Sensex and the Nifty have managed to hold on to reasonable levels. The speed of polarisation has increased significantly in the recent past.
    The second polarisation is on a sectoral basis. While some sectors, such as FMCG, IT and health care, continue to generate fabulous returns, others like real estate, capital goods, power and cyclical metals, are bleeding (see chart). Surprisingly, the ongoing rally is among counters that are supposed to be defensive. How did this happen?
    To begin with, the smart set of investors moved out of high-beta sectors, such as infra, capital goods and cyclical commodities, to defensive sectors like FMCG, pharma, IT and high-quality private-sector banks some time ago. Since these counters have generated positive returns in an otherwise falling broader market, the existing investors are not ready to sell even at higher valuations. Besides, more and more new investors are chasing these sectors. These momentum chasers have taken their valuations to unsustainable levels.
    Experts are worried about the acute polarisation, which is almost reaching the level of capitulation. When investors sell equities, giving up any previous gains in the stock price, so that they can move out of the market into less risky investments, it is called capitulation. “Capitulation is happening at both the ends of the market,” says Sanjay Sinha, founder of Citrus Advisors. “While there is panic selling at one end, there is panic buying at the other end,” he adds. While one end of the Sensex is quoting at 30-40 times, the other end is quoting at six to eight times. Clearly the current trailing Sensex PE is not displaying the true picture.
    The question that now haunts market participant is the duration for which the new momentum sectors will hold up the benchmark indices. The general consensus is that the sectoral and segmental polarisation may continue for some time. The market believes that the RBI and the government may not be able to bring the economy back on track anytime soon. A case in point is the failed effort by the RBI to support the rupee. It has only ended up hurting both the equity and debt markets.
    “It may take another 18 months for the broader economy to recover, and the market may regain its strength only after this happens,” says Phani Shekhar, fund manager, PMS, Angel Broking. With the economy still facing trouble and the interest rate outlook turning muddy, investors have no option but to hide behind the strong sectors.
    The ongoing polarisation may also continue for a little longer due to sectoral rotation. For example, most sectors that led the 1988-1992 rally, be it banks or construction, did not participate in the 1998-2000 rally. However, they came back with a bang during the 2003-8 one. Similarly, the sectors that led the 1998-2000 rally—IT, FMCG, pharma, telecom and media—underperformed during the 2003-8 one. What remains to be seen now is whether history will repeat itself in the current rally, which is being fuelled by the same sectors as the ones in 2000. During that period, FMCG and pharma had fallen behind after the initial thrust, leaving only the information technology, media and telecom sectors to lead the Sensex.
    No matter how the chips fall, it’s worth taking a closer look at these ‘momentum’ sectors, not least because of the divergent trends within. “Compared to a few good stocks, there are several bad ones in each sector,” says Shekhar. So sector-wise analysis won’t suffice. Investors need to be careful that they don’t end up with bad stocks from the right sectors.
Since the depreciating rupee is increasing the cost of imported raw materials, the FMCG sector is now facing margin pressure. Despite the correction, it remains the costliest sector. “Since the FMCG valuations are still high, the investors who are not tracking the market very closely can avoid this sector,” says Shekhar.
Though this sector is a beneficiary of the rupee depreciation and the economic recovery in the US, it continues to be plagued by domestic issues. One is the drug prices control order (DPCO), which forces them to sell at lower prices in the domestic market. Investors need to worry about companyspecific negatives, such as Ranbaxy, Wockhardt, and the like.
Private-sector banks
This sector has done well in these troubled times. But investors have started separating quality banks, such as HDFC Bank, which can report strong revenue growth without asset quality issues, from others. Revenue growth slowdown and asset quality concerns may crop up even in the ‘quality’ banks if economic growth slows further.
Currently, this continues to be the favourite sector because it is not affected by domestic problems. The hope of economic recovery in the US, a major source of revenue for IT companies, is another reason for the bullishness. The recent depreciation in the rupee will also help IT firms. However, don’t ignore the segmental shift. “I am not as bullish about mid-caps as the large-cap IT companies,” says Shekhar. Among large-caps, experts recommend TCS and HCL Tech rather than laggards like Infosys and Wipro.
This sector is a late entrant to the current rally. Several factors are working in its favour. The 2G scam and other issues plaguing the sector are acting as an entry barrier. With the latest entrants finding it difficult to survive, the competitive pressure in this sector has come down significantly. This explains why strong incumbents like Bharti Airtel and Idea, among others, have managed to report good numbers. Since Bharti is still struggling with its South African operations, investors bet on Idea