Globally, over the past decade, defensive sectors such as technology, consumer goods and healthcare have outperformed cyclical sectors such as financials, energy,industrials and materials. This is a structural trend, although there have been intermediate periods where cyclicals have outperformed defensives.
A key reason for the outperformance of defensives was the weakness in global economic growth. Also, there was a steady decline in interest rates, which implies a higher valuation multiple for future earnings and that benefits technology and healthcare stocks.
This phenomenon got accentuated in March post the Covid-induced downturn. No wonder the Nasdaq is at an all-time high, and in the S&P500 too, the top five stocks — Facebook, Apple, Amazon, Microsoft, Google — have driven most of the rally.
In India too, the healthcare and IT sector indices have risen 40-50 per cent year-to-date ( YTD) driving most of the recent market rally. The two sectors have benefited from the pandemic and the decline in interest rates.
In contrast, cyclical sectors have lagged. Stocks of banks, oil and gas utilities and infrastructure companies are still negative YTD. Some cyclical stocks are trading at a 15-50 per cent discount to their long-term average valuations.
However, we see a rotation currently, from defensives to cyclicals, globally and 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 the risk premium lower.
We have seen sector leadership changing from healthcare and IT to initially consumer discretionary and auto stocks, driven by better-than-expected demand, especially during the festival season.
This was followed by a sharp rally in metal stocks thanks to expectations of a global economic recovery and strong demand from China.
The banking and financials sector was the next major rally driver. Although delay in NPL (non performing loan) recognition is a key concern, clarity is expected to emerge in Q4 FY21 given that the moratorium has ended and restructuring timelines are limited. Bank NPLs are expected to reduce to earlier levels. The real estate sector too is catching up fast.
Industrials and capital goods could be the driver for the next leg of the rally as they are one of the key beneficiaries of the government’s structural reforms.
Overall, we see a rapid sector rotation in the market. We advise investors to stick with their SIPs in mutual funds as they may not be able to position themselves proactively. Also, the best way to play this would be to invest in asset allocation funds, as it can invest in diversified as well as thematic funds.
The writer is Co-CIO,
Aditya Birla Sun Life AMC