Globally, over the past decade, Defensive sectors such as Technology, Consumer Goods, and Healthcare have outperformed Cyclical sectors such as Financials, Energy, Industrials, Materials, etc. This is a structural trend although there have been intermediate periods where Cyclicals have outperformed Defensives.

A key reason for the outperformance of Defensives over Cyclicals was that global economic growth has been weak. A second reason was the steady decline in interest rates which implies a higher valuation multiple for future earnings and benefits Technology and Healthcare stocks as their earnings are typically back-ended. This phenomenon got accentuated post the COVID-induced downturn in March. No wonder that the Nasdaq is at an all-time high and even for the S&P500, the top 5 stocks which are all technology stocks (Facebook, Apple, Amazon, Microsoft, Google) have driven most of the rally.

We have seen a similar pattern in India. The Healthcare and Information Technology sector indices have risen 40-50% YTD and have driven most of the recent market rally as these two sectors have actually benefited from the pandemic as well as from the decline in interest rates. In contrast, cyclical sectors have lagged and some of them such as Banks, Oil & Gas, Utilities, Infrastructure etc. are still negative YTD leading to a marked divergence in performance. In fact, some of the cyclical sectors are trading at a 15-50% discount to their long-term average valuations indicating that they are deep value.

However, we are seeing a rotation currently from Defensives to Cyclicals, globally as well as in india, driven by a) expectation of above-trend GDP growth, b) ultra-lose monetary policy, c) continued USD weakness which is driving commodities higher, and d) the easing of major market risks (US election and COVID-19 vaccine advances) driving risk premium lower. In addition, India has higher bounce-back potential from a vaccine as India’s GDP growth declined more other countries and is the best positioned major region to benefit from the recent structural reforms as well as productivity gains of digitization.

Over the past couple of months, we have already seen sector leadership changing from Healthcare and IT to initially Consumer Discretionary and Auto stocks driven by better-than-expected demand, especially during the festive season, and a pickup in volumes projected going into next year. This was followed by a sharp rally in the Metals sector where expectations of a global economic recovery and strong demand from China have driven metal prices to record levels.

The Banking and Financials sector was the next major sector to lead the market higher. Although delay in NPL recognition is a key investor concern, clarity is expected to emerge in 4Q FY21 given that moratorium has ended and restructuring timelines are limited. Bank NPLs expected to reduce to earlier levels. Overall, Banking sector NPAs should be manageable despite COVID crisis and credit growth is expected to normalize.

The Real Estate sector is also catching up fast. Affordability levels have reached 2004 levels due to record low mortgage rates and prices remaining stagnant for long. Buyer sentiment is improving with government support such as stamp duty cuts in some states. Debt yields have fallen too, driving investor demand into housing. Market consolidation continues post COVID - organized large developer share is rising. Liquidity for developers is also improving due to asset sales as foreign investors are lapping up REITs.

Could the Industrials and Capital Goods sector be the driver for the next leg of the rally? It could be possible as it is one of the key beneficiaries of the structural reforms introduced by the government. The push for AatmaNirbhar Bharat should drive domestic manufacturing, private capex, import substitution, as well as exports. The PLI Scheme, which was recently expanded to 13 sectors from 3 earlier, should help to attract FDI across sectors.

Overall, we are seeing rapid sector rotation in the market causing market participants to be on their toes. In such an environment, it would be advisable for investors to stick with their SIPs in Mutual Funds as they may not be able to position themselves proactively and would miss out on the rally. The best way to play this would be to invest in an Asset Allocation Fund as it can invest in diversified as well as thematic funds and take appropriate exposure to sectors and themes.

The views and opinions expressed are those of Mahesh Patil, CIO – Equity and do not necessarily reflect the views of Aditya Birla Sun Life AMC Ltd (“ABSLAMC”) /Aditya Birla Sun Life Mutual Fund (“the Fund”). ABSLAMC/ the Fund is not guaranteeing/offering/communicating any indicative yield on investments. ABSLAMC or any of its officers, employees, personnel, directors make no representation or warranty, express or implied, as to the accuracy, completeness or reliability of the content and hereby disclaim any liability with regard to the same. Recipients of this material should exercise due care and read the scheme information documents (including if necessary, obtaining the advice of tax/legal/accounting/financial/other professional(s)) prior to taking of any decision, acting or omitting to act. Further, the recipient shall not copy/circulate/reproduce/quote contents of this interview, in part or in whole, or in any other manner whatsoever without prior and explicit approval of ABSLAMC.

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