Agood low-hanging fruit is hard to spot at times, especially when the foli-age is thick or the branch is loaded. If the bounce in the stock market over the past six weeks gives you renewed confidence to shift to equities, even if partially, you should know what that means.

After a year-long slump, many sto­cks are quoting at such valuations that it is hard to tell whether they are abnormally low or are the new normal for the market. Stock valuations have come off sharply over the past few months with significant deterioration in India’s premium over other emerging markets. One pointer to this could be the mismatch between growth on balance sheets and stock prices.

In the nine months ended Dece-mber, companies in BSE bankex saw sales grow 36 per cent and profit 10 per cent, but the index itself fell 30 per cent compared with 21 per cent drop in Sensex. The metal index fell 43 per cent while companies that make it reported 28 per cent sales growth and 8 per cent profit growth. It’s the same story with oil and gas, power, realty and consumer durables segments. During the same time FMCG firms reported 18 per cent sales growth, 21 per cent profit growth and 12 per cent jump in the index that represents them.

FMCG stocks — the typical defensives — are today quoting at a price-to-earnings (PE) multiple of 30, far above their long-term average; while banking stocks are quoting at a PE of 15 compared with their long-term average of 22-24 last seen during 2007-2008. Auto stocks are quoting at 17 compared with an average of 19-21 in 2011 and 24-27 in 2009. Metal stocks are near their multi-year low of 12 compared with 22-26 during 2009-2010. Oil and gas stocks are quoting at an average PE of 19, compared with the highs of 21-26 in 2009-2010.

Mind you, PE or the price paid for every rupee of profit earned per share is a function of sentiment and perception. Yet, many analysts agree there is an opportunity to grab.

“We believe valuations have hit the trough, with more than 20 per cent stocks quoting at the same levels they were when Sensex was at 8,000, while 25 per cent of them trading at less than the capital employed. This intuitively implies that one can buy companies at values on par with promoters. Valuations of most sectors (construction, power utilities and telecom) are quoting at 70 per cent discount to peak valuations,” IDFC Securities analysts Nikhil Vora, Kavitha Rajan and Swati Nangalia said in a report.

What this means is that business cycles that were on a downtrend have seen their nadir and are about to turn around.

But it is not everyone’s cup of tea to adjust investment decisions to the ebbs and flows of a business cycle. It requires an understanding of the relationship that an industry enjoys with the economy.

For instance, infrastructure sector stocks have seen prolonged slump over the past two years after the phenomenal growth during 2003-2008. While most market analysts attribute this to policy inertia at the government level, the segment also suffered due to high interest rates, high inflation and the overall slowdown in the economy – all parts of an economic cycle. And for all you know, this is one sector that has to grow rapidly if the economy has to grow at 8-9 per cent.

Other segments that suffered due to high interest rates were banking, auto, realty and consumer durables as well as some allied sectors such as media.

The ‘shift to cyclicals’ is already visible in the market since the beginning of the year. The market rally so far this year has seen Sensex gain 13 per cent, while realty index has surged 29 per cent, bankex and capital goods index 27 per cent each, power index 20 per cent and auto index 16 per cent.

Cyclical stocks are those where businesses are highly linked to the flow of the economy as opposed to non-cyclical or defensive businesses that keep making profit regardless of economic gyrations as they are in businesses of goods and services that are essential consumer needs — such as food, power, water, clothing, medicine and healthcare.

Many analysts are suggesting inve­stors to sell some of their defensive stocks and move into cyclicals. An analyst with global brokerage BNP Paribas last week prophesied 40 per cent surge in cyclical stocks in Asia this year.

“This year you may want to be selling your defensives and go long on cyclicals – be it industrials, technology or consumer discretionary,” Adrian Mowat, chief Asian and emerging market strategist at JPMorgan Chase, said about the Indian market in an interview with Bloomberg last week.

“While government inaction, slower FII inflows, currency fluctuation, inflation, interest rates and low earnings growth projections offer extreme discomfort at this point and fatigue among investors is of the highest order, we believe pockets of comfort are emerging. For, many of these variables set to change or reverse,” brokerage IDFC Securities said.

“With interest rate reversal on the cards, we suggest moving into inte-rest rate-sensitives such as infrastructure and financials and trimming positions in global plays such as IT services, metals and oil & gas. Further, we have increased our weights in the mid-cap portfolio and marginally reduced positions in the expensive consumer goods space,” the brokerage said

But doomsday soothsayers still suggest sticking to defensives for another year, or at least for the first part of 2012, as they expect euro zone crises, slow revival in the US, uncertainty on the crude oil front due to the troubles on the Iran front and domestic woes of high fiscal deficit and those arising out of the lag effects of high interest rates, economic slowdown and political uncertainty to keep growth under check.

“The manner in which the market has rallied has raised expectations of more gains. However, one must not lose sight of the risks confronting the market – both domestic as well as external. Things could get trickier going forward as strong money flow is driving the current ascent,” said D Kannan, managing director of Kotak Securities.

bijoysankar@mydigitalfc.com