All-weather friends

Many other sectors can turn defensive to give FMCG and pharma company

For the markets, the season changes every quarter. A sector in favour last quarter may not necessarily find takers in the next. Investors find warmth in FMCG and pharmaceuticals stocks during the bear chill but turn cold to them in a bull market. IT stocks fluctuate along with the rupee, a factor of the health of the developed economies: a strong US economy boosts the dollar and makes our exports competitive. The fortunes of the real estate sector wax and wane with rising and softening interest rates, reflecting the state of the domestic economy. Nothing illustrates the volatile taste of the market better than the changing outlook of banks and telecom. After viewing it with trepidation for the rising non-performing assets and lust due to hefty treasury income on low interest rates for a few quarters, the banking sector now seems to be firmly entrenched on investors’ checklist as the best bet to ride on the coming growth wave. A favourite till a few quarters ago for mimicking the growth story of the new liberalized India, telecom has been beaten down after being washed with debt undertaken to bid for 3G and BWA licences and falling margin on intensifying competition. It is not necessary that these two sectors would continue to enjoy their current status a few quarters down. Like shifting sand, their fortunes can take a reverse turn due to global and domestic economic environment or company-specific developments. Rising interest rates are more likely to expose the weak links among banks, taking down the sector. Valuations of telecom stocks are already looking attractive and could further enhance their appeal if there is a major shakeup. Ditto for aviation, another reforms era success story, which spawned competition, cannabilisation and, eventually, consolidation.

It is now pretty evident that every cyclical phase in the market throws up surprises. New sectors emerge and old and mature industries blip out. If the prosperous last decade of the last century closed with the big bang debut of Internet companies, the new century washed ashore with the belly-up corpses of many of these startups. If telecom ruled the waves for a brief period, so did real estate. Even as tech stocks staged a comeback, riding on the success story of Apple’s iPod, iPhone and iPad, the market returned to its manufacturing roots, with crude oil dictating the mood swings as a barrel became worth more than $140 not because of cut in production but from growing demand from China and India. If the allure of gold proved irresistible so did the old world charm of basic metals such as copper, steel and aluminum on the US housing boom and so also basic food items such as sugar, corn and wheat as the emerging economies sought improved lifestyle. As the first decade of the new century drew to a close, the housing boom fuelled on cheap money crashed under its weight, pulling down with it financial institutions. The choking of the credit pipeline and liquidity to the stock markets grounded to a halt the bull-run in commodities. If the dotcom IPO rush characterized the excesses of the previous bull-run, it was the bursting of the real estate bubble that concluded the latest. The collapse of Lehman Brothers, exposing the rot in the financial services, is considered the defining moment for the about-turn of the market. Yet, the fall of Enron or WorldCom or Long-Term Capital did not usher in a bearish phase. Invariably, it is one sector that gathers enough momentum to propel and prick the feel-good sentiment. It is during times of distress that mature industries gain prominence. Some of them continue to do well even in good times but are overwhelmed by the flavours of the season. Perhaps it would be appropriate to call them all-weather friends of investors. Their presence is comforting but never domineering in a market rally like, say, tech or telecom. Just as institutional investors hedge their cash positions in the derivatives market, investors tend to earmark certain share of their portfolio for defensive sectors to ensure stable returns.

Considering the increasing reliance on steady performers to see through volatility, it is surprising the small numbers of these sectors. One reason is that it takes years for an industry to attain maturity. Some promising sectors peter out after a few years, while many older ones suffer from cyclical demand. The trick will be to correctly identify those that have the DNA to survive rough weather and retain sanity during exuberance. If soaps, detergents and medicines are used during boom or doom, so is the people’s need to communicate. Intense competition has battered telecom stocks but this could be the growing up pains as consolidation. The FMCG sector too has and is facing competitive pressure on margin. It is trying to get a handle on the situation by reducing weights and pushing volumes and foraying into food processing and over-the-counter pharmaceuticals. Telecom players are eyeing 3G, BWA and data transmission for growth and may have to foray into content and hardware to offer the entire value chain to subscribers. If pharma can be the perennial consumption theme, so can be hospitals and education, sectors yet to see substantial listings on the stock exchanges. Private equity players are already betting on them as the next growth stories. So far, banks were considered a cyclical play, whose future was tied to interest rates. This perception has changed as the sector is set to enmesh with India’s growth story. Besides, treasury income in a low interest-rate era compensates for fall in fees and lending spreads during a bullish phase. Unfortunately, crude-based raw materials and dependence on cotton crop have robbed textiles, an old and indispensable sector in the economy, from acquiring the defensive tag. The technology upgradation fund is contributing to the industry’s modernization. Infusion of capital to achieve economies of scale can make it a global hub like the automobile sector is poised to become and its dependence on labour turned into an advantage to make it the next defensive candidate. Waiting on the sidelines but never far from the subconscious is the entertainment sector. What better way to cope up with the bear phase than be transported into a fantasy tale of good triumphing over evil or the underdogs taking on the champions?
MOHAN SULE