The Indian market has been on a roll. It’s made a new high with the flagship Nifty crossing the psychologically important 12,000 barrier.
However, the performance is mainly driven by top 15 stocks, which together contribute about half the weight of the Nifty index. The broader markets have remained weak with small and midcap indices down significantly from their peaks.
The economic backdrop to such enthusiasm in the markets is quite the opposite. Growth has recently made a multi-year low, with real Gross Domestic Product (GDP) growing at 4.5 percent in Q2 FY20. The slowdown is predominantly driven by a slide in private consumption, partially offset by an improvement in government spending.
Against this backdrop, we discuss our expectations about sectors that can do well. We see telecom, utilities and financial services outperforming over the medium term.
Telecom has remained hyper competitive for almost a decade now, which has resulted in significant consolidation in the industry. The incumbents had generated weak cash flows and delivered sub-par returns on capital during the phase when the tariff was low. Recently, we have seen a sharp increase in tariffs, which has been implemented by the entire industry. We expect this to improve the sector’s health and hence, reflect in its outperformance.
The utilities sector includes companies with regulated businesses, which normally generate fixed returns on capital. Our assessment is that the sector is deeply undervalued and could be re-rated in the medium term.
Financial services are a significant beneficiary of the recent corporate tax cut. Most companies from the sector saw an increase in not just earnings, but also sustainable return on equity (RoE). We expect the fair valuation multiple for the sector to go up, which could result in a strong show.
In contrast, consumer staples and discretionary and material sectors are likely to underperform. Demand weakness may hit both consumer staples and discretionary sectors where the valuations are not supportive either. The materials sector too may get the chills on global growth headwinds and a prolonged trade war, which could lead to softness in end commodity prices.
Also, most companies of the sector find it difficult to generate respectable RoE on a sustainable basis, which makes us walk the thin line.Vinay Paharia is Chief Investment Officer, Union Asset Management Company Private Ltd. Views are personal.