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Safe Isles In Rough Waves

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Safe Isles In Rough Waves
VK Vijaykumar - 31 July 2021

Globally, we are in a ferocious bull market. The excessive valuations in the markets and the possibility of a major crash have become talking points. 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 frothy valuations are unsustainable and, therefore, a crash is on the cards.

The Reserve Bank of India too, in its 2020-21 Annual Report, warned about a stock market bubble.

There is a near consensus that valuations are excessive. The famous Buffett Indicator Market Cap to GDP (Gross Domestic Product) at 205 per cent is way ahead of the historical average. The PE (Price-to-Earnings) ratio for S&P 500 at 46 is excessive compared to the average of 16. So, the mother market of the US is ripe for correction, but no one knows when the crash will come. And, when the mother market tanks, all markets – developed and developing – are hit, of course, the degree of impact differs depending on the macros.

Back home in India, all matrixes of valuation point to excesses. In India, the long-term market cap to GDP ratio is around 77 per cent, the long-term PE multiple is around 16, and the median Price to Book value is 3.23. Where are these valuation parameters now? The Market Cap to GDP is 115 per cent, one-year forward PE is around 22 and Price to Book is around 4.44. All three indicators are flashing red.

In brief, there is no ‘margin of safety’ in the market now. Investors should exercise caution in their investment strategy. This is not the time to aggressively invest in the market. This is the time to 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.

Let’s take a look at various sectors that can assure some safety for your money and where investors can remain invested and even consider buying on declines.

Information Technology: IT is a sector that gained from the pandemic. With digitisation in the 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 with TCS, Infosys, Wipro and HCL Tech 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 depreciation in the rupee will benefit the sector and, therefore, IT will be relatively resilient even during a sharp market correction.

Financials: Most financials, particularly leading private sector banks, have been underperformers in the recent rally. Non-performing assets (NPA) have become major headwinds for the sector. But top private lenders are increasing their market share at the expense of their state-run peers. Private banks’ share in loans has risen from 21.26 per cent in 2015 to 36.04 per cent in 2020. Barring the top three, most public sector banks are likely to grapple with funds crunch, while the top private lenders are set to exploit the imminent boom in lending with their hefty cash-piles.

Since the banking index has been underperforming and the valuations are not stretched, private sector banks look good for investment. Also, the top private marques in fintech, mortgage lending, and life and general insurance look good for investment since they have many years of potential impressive growth ahead.

Telecom: The explosion in data consumption 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 overdue, will add substantially to the bottomline.

Healthcare & Pharmaceuticals: The Covid shock has forced nations to focus more on healthcare. India, being the pharmacy of the world with exports of $24.4 billion in 2020-21, stands to benefit. Particularly companies with competence in Contract Research and Manufacturing Services (CRAMS) and leaders in Active Pharmaceutical Ingredients (API) 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 & Auto Ancillaries: Besides IT and pharma, two sectors that stand to gain from the ongoing export boom are textiles and auto ancillaries. The depreciation of the rupee from 72.50 to a dollar in May to 74.59 on July 14 is a boon for exporters. It is likely to weaken further. The textile industry is showing a clear upturn in fortunes. In the fourth quarter of 2020-21, a sample of 122 listed textile companies registered an aggregated year-over-year rise of 27 per cent in revenues and an impressive 123 per cent 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 the currency depreciation has the potential to boost the bottomline substantially.

Capital Goods & 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 underway as a major driver of economic expansion. 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.

Metals: The Nifty Metal index has been the leader in the 2021 rally with returns of 62 per cent vis-à-vis Nifty return of 14 per cent year-to-date. Even after this big run up, the valuations of the sector are reasonable. It appears that the metals cycle, which has been depressed for a long, is set for a long-term expansionary phase. The robust economic recovery in the US, China, and Europe bodes well for metals like steel, zinc, aluminium
and copper.

Mid-caps & Small-caps: In an expansionary phase of the business cycle, mid-caps and small-caps normally outperform large-caps. For instance, as of July 7, the one-year return from the IT market leader TCS is 49 per cent, while the one-year return from Persistent Systems is around 400 per cent. This outperformance of the mid-caps and 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. Identifying potential mid-cap and small-cap winners is not easy. Therefore, the ideal investment strategy would be to invest in the mid-cap and small-cap space through mutual fund SIPs.


The author is Chief Investment Strategist at Geojit Financial Services

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