Time to invest in cyclicals as economy gathers steam

Despite the large economic impact of the Covid-19 pandemic, the markets have recovered sharply even though the performance among individual stocks has been quite polarised.

After a 52 per cent rally in the benchmark indices – the S&P BSE Sensex and the Nifty 50 – form their respective March 2020 lows led by pharmaceutical, automobiles, information technology (IT) sectors and index heavyweight Reliance Industries (RIL), analysts now suggest investors should now rotate money to cyclical plays like banks and cement as the economic activity picks up pace.

"As the market repositions itself for the normalisation of the economy, analysts at CLSA believe that core domestic sectors should start outperforming the global defensives like IT and pharma," wrote Vikash Kumar Jain, an investment analyst at CLSA in an October 16 note.

Despite the large economic impact of the Covid-19 pandemic, the markets have recovered sharply even though the performance among individual stocks has been quite polarised.

For instance, sectors which are seen as Covid-19 resistant, such as pharma and IT have been market leaders.

Nifty IT and Nifty Pharma indices have moved up 80 per cent and 75 per cent, respectively from their March 2020 low, ACE Equity data show. In comparison, the Nifty50 index has gained 52 per cent.

At the other end of the spectrum are Nifty PSU Bank, Nifty Bank, Nifty FMCG and Nifty Realty indices that have been relative laggards, and moved up 1 per cent to 45 per cent during this period, data show.

"This polarisation is also evident from the fact that only 15 per cent of this universe of Covid-19-impacted stocks are above pre-Covid-19 levels versus a much larger around 70 per cent of the Covid-19 resilient names which have surpassed their respective pre-Covid-19 stock prices," Jain of CLSA wrote.

As an investment strategy, those at Credit Suisse Wealth Management, too, share a similar view and suggest investors increase exposure to private banks from a 12 – 18 month horizon.

"The economic growth momentum has picked up pace and the upcoming results season will provide more color on the strength of the broad-based rally in the market," wrote Jitendra Gohil, head of India equity research at Credit Suisse Wealth Management in an October 15 co-authored report with Premal Kamdar.

Even though the economic activity has picked up pace over the past few months, analysts at Nomura caution against a sharp rise in Covid-19 cases during the festive season.

That apart, they believe the underlying weakness in the labour market is worrying as it reflects continued pressure on household incomes, which can be a medium-term headwind for consumer demand.

In this backdrop, though analysts do remain bullish on the road ahead for the markets, they do remain mindful of the event risks that lie ahead and the current valuation at which the Indian markets trade at.

"While the valuation is very expensive – 12-month forward price/earnings (P/E) of 21.2 at all-time high levels – hopes of further fiscal stimulus in the US (as high has 10 per cent of GDP), development on vaccine and revival in economic activities in India may keep investor’s interest high," Credit Suisse said.

At around 18x P/E on normalised FY22 earnings per share (EPS), those at CLSA believe that absolute upside for the index may be capped as it is less than 10 per cent away from its 15-year high of 19.6x seen in January 2008.