Bet on beaten-down stocks

Tags: Opinion

Up ahead, cyclical sectors including auto, industrials, construction and real estate will start to do well, even though there are various risks on the horizon

Indian equity markets have given 10 per cent return this Samvat as measured by the benchmark Nif­ty’s performance. While we have outperformed other emerging markets, we have just about matched the performance of the developed world on aggregate.

However, given the several macroeconomic challenges that we have struggled with through the year, be it the deceleration in GDP growth or record high fiscal and current account deficits, this performance isn’t all that bad.

Going forward, we think that the renewed reforms thrust by the government in addition to the easing liquidity in the system will generate a meaningful recovery, both for the country’s economic growth as well as corporate India’s financials.

This in addition to the fact that the qualified institutional placement (QIP) market is now opening up should act to de-stress Indian firms’ balance sheets. Valuations are reasonable for most segments of the market. All of these, in our view, should generate a conducive environment for Indian equities to move higher and consequently generate healthy returns for investors. This broader recovery will also have significant portfolio positioning implications.

Even a cursory look at the performance of individual sectors of the market this Samvat reveals that most of the outperformance was concentrated in a few sectors such as FMCG, cement and pharmaceuticals. In fact, this has been the trend for several quarters now. Defensive stocks and sectors have outperformed their cyclical peers by a significant margin. There were two factors at play here — market participants were cautiously positioned owing to the poor equity market performance of the past few years and, hence, preferred the relative safety of defensives. At the same time these were few pockets that were still delivering strong financial performance even as the economy’s down cycle took a toll on the performance of the cyclical sectors. Investors have flocked to these growth stocks even with valuations in some of these names reaching stratospheric levels.

Our work shows that for the past three years running, growth stocks have outperformed value stocks in India. However, over the long-term (say, the past 10 years) value stocks seem to do much better. Indeed, value stocks have outperformed the broader markets as well as the growth group over the past 10 years.

With the economy looking to turn for the better in India, we think the more sensible names from the beaten-down value stocks should look to turn the corner, both in terms of financial as well as stock market performance over the next year. Stocks from the likes of Bharti, Ashok Leyland and Tata Steel, to name a few, can be considered. On related lines, this also implies that a lot of the cyclical sectors such as automobiles, industrials, construction and real estate will start to do well.

Overall, we are optimistic about the prospects of equity as an asset class in India in the next Samvat. Investors, however, should remain aware of the various risks on the horizon as we enter the new Samvat. These risks range from the looming fiscal cliff in the US to the uncertainty arising out a potential early general election in India. Also, the investment cycle is unlikely to go back to levels seen in the middle of the last decade and hence, market upmoves should be more measured. In this context, investors should stay clear of high beta stocks, just for the sake of it to benefit from this recovery.

We also think banking stocks in spite of their cyclical nature will feel the heat in the coming year. With deteriorating asset quality and concerns over the inadequacy of disclosures, investors should continue to steer clear of this space. Over the past year, while markets have been wary of public sector banks, private banking stocks have done pretty well. However, we think similar challenges exist in the private banking space as well and with the lofty valuations that they enjoy at present, both on an absolute basis and relative to their public sector counterparts, the risks are significantly higher in the private sector banking space.

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