Markets back in defensive mode

The euphoria that had begun in the run-up to Narendra Modi’s victory in the Lok Sabha elections seems to be waning, with the stock markets returning to the defensive mode. Over the past three months, the weight of information technology (IT), pharmaceutical and fast-moving consumer goods (FMCG) companies has risen sharply on the indices.

These three sectors now account for a little more than a third of the combined market capitalisation (free-float) of the National Stock Exchange’s Nifty50 index, compared with 31 per cent at the end of May this year. The only exception in this pack has been ITC, whose stock is languishing due to the current health minister’s strong anti-smoking stance. The defensive stocks’ share on the index had peaked to around 37 per cent in October last year.

In contrast, cyclical and interest-rate-sensitive sectors are now retreating. There has been a decline in the weight of top names in the capital goods, construction & infrastructure, metals & mining, power, real estate and cement sectors. The only exception have been private sector banks and automobile manufacturers, whose index weights have risen since May this year.

Analysts attribute the change in trend to cyclical companies’ failure to live up to the market’s expectations in their June quarter earnings. “The rally in cyclicals was built on hope of an early revival in capital expenditure cycle and economic growth. The June quarter results, however, showed a revival was still a few quarters away. So, investors moved their money to FMCG, IT and pharma companies, which have better earning visibility,” says Devang Mehta, senior vice-president and head of equity sales at Anand Rathi Financial Services.

Including Bharti Airtel (telecom) and Zee Entertainment (media), the index weight of defensives and consumer staples has risen to 36 per cent from around a third at the end of May. Both of these stocks have outperformed the market in the past three months.

Following in the footsteps of Hindustan Unilever, Sun Pharma, Cipla, Lupin and Tech Mahindra, which scaled new highs earlier this month, the stock prices of Tata Consultancy Services, HCL and Dr Reddy’s Labs touched their respective life-time highs on Friday. These companies have together accounted for over half the incremental rise (52.7 per cent) in the Nifty since June this year. By comparison, there was a two per cent decline in the combined market value of these companies during the October-May rally. In that period, financials, oil & gas and infrastructure companies had accounted for three-fourths of the index’s incremental rise.

Mehta expects the trend to continue for some time, given the continued earnings momentum for IT and pharma companies on the back of a weaker rupee and an economic recovery in the US, their key market. In the June quarter, the combined net profit of IT and pharma companies rose 45 per cent and 1,000 per cent (due to exceptional items), respectively, against the near-flat growth rates reported by banking & financial, capital goods and construction & infra companies.

Experts say sectoral rotation has completed a full cycle and markets are back to the pre-2013 trend. “Given the uncertainty regarding a credible revival in the domestic economy, investors are going back to safer bets, such as export-driven companies and those with quality earnings. This is just as they had done in the period before September 2013,” says Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.

Others attribute it simply to the valuation differential between cyclicals and defensives. “Initially, the rally was limited to cyclical and rate-sensitive stocks; the defensives did not participate at all. This made the latter cheaper. Investors are now taking advantage of that, but it might reverse again,” says G Chokkalingam founder & CEO, Equinomics Research & Advisory.