Defensive To Remain In Limelight
Dalal Street Investment Journal|August 17 - 30, 2020
With the Sensex recovering nearly 50 per cent from its March lows it is becoming a risky proposition for investors and traders to bet on high beta stocks. Low beta stocks could do the trick in the current market situation. Defensive stocks once again may lead the market rally as the craze for the financials and high beta stocks fizzles out slowly. Yogesh Supekar and Geyatee Deshpande explain why it makes sense to park extra monies in defensive stocks while the DSIJ Research Team churns out the best contenders in the defensive space to beat the markets
Yogesh Supekar and Geyatee Deshpande

Sensex and Nifty, key benchmark indices that are the barometer of the health of the Indian equity markets, have risen almost 46 per cent each since their March 23, 2020 lows. Such a sudden and record-breaking rise, though financially satisfying, has got experts worried – the single biggest concern being ‘valuations’. The valuations are way too far-stretched to not predict a market correction. If we simply look at the PE levels for 2020 in all the months, we get a fair idea.

If we look at the above table, we see that the PE has expanded steadily since the correction in March. One might say that the PE has been the highest in August at 30.38 for 2020. That may not seem very informative per se but when we realise that the Nifty PE has never been so high ever, it can be an alarming piece of information for both traders and investors. Even in 2008, when the markets were pumped up by liquidity and frenzied leveraged buying, the PE for Nifty in January 2008 was 25.33. The correction pushed the PE for Nifty towards 12.73 in January 2009 and eventually when the markets recovered, the PE clawed back to the 25.33 levels by October 2010.

Thus, we saw the PE contract by almost 50 per cent following which it expanded from the lows by nearly 100 per cent. In 2020, in spite of the voracious fall, the PE contracted from 27.96 to 20.38, indicating a 30 per cent contraction. In the wake of a recovery, Nifty is eventually trading at the 30.38 level, indicating a 50 per cent expansion in PE since April 2020. Needless to say, the current price recovery in markets is without the support of recovery in earnings and hence the valuations could be unsustainable in the near term.

So, either the earnings have to grow fast or the prices should correct to bring valuations to fair levels. Robust earnings’ growth owing to slower economic growth and the pandemic situation looks far more difficult than a price correction. Also, the data compiled by Bank of America suggests that S & P 500 has averaged a loss of 0.03 per cent between August and October since 1928, making it a worst three-month period for the broader market index. The data also highlights July to be the best month historically for S & P 500 if we study the results since 1928.

Taking the Lead

Sensex made its 2020 highs on January 14 at 41,952 and is down by almost 10 per cent since then. In the same period, BSE IT index was up by almost 12 per cent. As many as 48 IT stocks are trading higher than they were on January 14, indicating the broader outperformance of IT stocks in spite of severe pandemic-led correction. Some of the IT bellwether stocks such as Infosys, TCS, Wipro, HCL Technologies and Larsen and Toubro Infotech feature in the list of stocks that surpassed their pre-pandemic level stock prices. Similarly, pharmaceutical stocks showed a tremendous rally in tough times. As many as 57 pharmaceutical stocks are trading higher or above the pre-pandemic level stock prices. The average returns of 67 pharmaceutical stocks considered for the study touched 58 per cent since January 14, 2020 when the Sensex was at its peak in 2020.

If history were to repeat itself, we are set for a muted market for the next three months starting August. Hence, switching to defensives can be most profitable tactical portfolio move for investors. Whenever a price correction in markets is expected, time and again it is realised that defensives lead the market. Actually, 2020 belongs to defensives. For obvious reasons, pharmaceutical stocks have rallied and so have the IT stocks. Both these sectors along with FMCG have been least impacted by the lockdowns. The table below highlights the outperformance of these three sectors on an YTD basis.

The quarterly earnings have been positive for IT companies. Hexaware Technologies, Tata Elxsi, Indiamart Intermesh, Infosys, Larsen and Toubro Infotech and Mindtree are just some of the IT entities that have come out with positive results this season, thus keeping investors’ interest in IT companies at an elevated level. In the pharmaceutical sector, companies such as Laurus Lab, Torrent Pharmaceuticals, Ajanta Pharmaceuticals, Piramal Enterprises, Alkem Lab, Cadila Healthcare, Aarti Drugs, SanofiIndia, Alembic Pharmaceuticals, Divi’s Lab, Granules India and Zydus Wellness impressed investors with positive results, thus raising investors’ confidence in the sector.

The pharmaceutical stocks have rallied considerably and hence are not cheap any more but investors have to understand that these scrips are rallying after almost five years’ underperformance. Hence, the steady price performance may continue a little longer than investors’ expectations. In fact, the Indian pharmaceutical sector is expected to be stable for the remaining part of the year. A positive factor is that the production-linked incentives for API manufacturers are intended to reduce dependence on imports from China.

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