What to buy in a bull market?

May Market Mayhem

The last few weeks have been heady for the Indian stock markets. Since the first set of leaked exit poll results, stocks have surged on new-found confidence that the new government will banish all that has ailed the Indian economy. Within a fortnight, analysts have gone from recommending the staple stocks for the last 2-3 years to ones they hadn’t mentioned in a long while. The transition from “cautious optimism” to “full-blown confidence” has been dramatic. Three charts summarize this turnaround since the beginning of May 2014.

Chart shows the performance by market cap. After a sedate start to the month, the first surge happened in the 2nd week when exit poll results were leaked / came out. The second surge came when the official results were declared. This 2nd surge however seemed to ignite the midcap and smallcap segment which have blown past the larger companies. Overall small and mid caps have gained nearly 20%  and 17% in just over two weeks! And I’d come to expect only down moves of such magnitude from markets given the last six years.

maymarketmayhem1

In ‘Election 2014 fever and deciding when to buy‘, I spoke of the Market, Industry & Company framework of deciding whether and which stocks to buy. So how have the various industry sectors done in the month of exuberance? Chart indicates almost all sectors have done well in convincing investors of excellent future prospects. But again, some sectors / themes have done much better than others. PSUs (31%), Power(31%), Consumer Durables(24%), Metals, Oil&Gas (both 20%) and Capital Goods (18%) have been the biggest gainers from “Modi-euphoria”.

maymarketmayhem2

But not all sectors have had it good. The sectors that until last month were the staple of every analyst’s recommendations, have lost favour. Hardest hit has been healthcare (-8%) followed by IT (-4%) and FMCG (-0.3%) stocks.

maymarketmayhem3

Are markets starting on a tearing climb to unprecedented levels that will last the next decade as stated by Rakesh Jhunjunwala, .

So should we all be hurling all our luggage onto the train before it leaves the station?

With so much happening, how does an investor hope to stay calm? And more importantly, how does he incorporate the rapid movements into his frame of reference to make decisions?

Get perspective

Remember how stock prices incorporate collective expectations of future performance? Theoretically, only a sudden event vastly improving its circumstances should move it’s stock price significantly. Like if it’s R&D patented a manufacturing technique cutting costs by half or its only competitor lost it’s production facilities to a natural disaster.

Currently, India stock market expectations are something like this: New government makes sweeping policy changes >> Resulting in public investment into large infrastructure, power projects >> creating jobs and therefore demand for consumer goods >> higher demand inducing private investment into adding capacity >> creating more jobs >> so on and so forth as a virtuous cycle…[all this while also reigning in inflation to under 5% and hoping the world economy doesn’t collapse under the weight of cheap credit courtesy Quantitative Easing]

In other words, there are a host of “ifs” and “buts” that need to be resolved before the benefits start percolating into corporate performance and then into stock prices. This is a process that, at best,will take a few years and at worst, might not happen given these are based on actions of politicians.

Look at a longer timeline

Since market interest in individual stocks follows interest in the sector, it’s useful to take a slightly longer term view of the returns from various sectors over different timelines. Chart shows this comparison showing returns over 3 years down to the last 3 months.

what to buy sector returns_14may26

Consider the performance of the FMCG index against the Power index. Over a 3 year period, FMCG stocks have risen 80% but very little of that rise has been over the last year while Power stocks show negative returns over 3 years but have surged in the last 3 months by over 50%. Healthcare and IT show behaviour similar to FMCG while PSUs, Capital Goods and Metals have moved like Power stocks. This means the “sector rotation”(exhibit 1, 2) that analysts are going on about started several months ago. Another example of the talking heads identifying a trend post-facto and citing it as the way forward.

 Take (in)action, stay still or…

Some experts have specific advice on “reducing IT and pharma” and “moving into cyclicals” (i.e. capital goods, power, metals) while some suggest “looking for value”. Problem is, in a market where a stock like Suzlon,  (negative earnings per share (EPS) for last few years and so indebted that it’s interest payments exceed operating profit), can see 60% price appreciation, there is a conspicuous absence of rational decision-making.

If you’ve been a regular investor over the last couple of years like I’ve suggested in SIP. Don’t Guzzle this is a good time to log out of your brokerage account, go on vacation and don’t make any buy-sell decisions for the next couple of months. Since most holdings would have appreciated by double digits over the last few months, staying away shouldn’t cause too much “separation anxiety”.

On the other hand, if you’ve not been a regular investor and the current scenario fills you with regret about not having been one, caution! You’re at risk from your behavioral biases. Meaning, you might stay out for another month or two but if in that time markets keep rising, you might find your self-control being decimated by the “notional losses” from not having invested. At this point you’re most at risk to make spectacularly poor decisions, like piling into a bunch of stocks at their 52 week highs. To mitigate this self-destructive behaviour, I suggest going contrarian and look for opportunities in Pharma and IT, two sectors that are not exactly “flavour of the month” and also, whose performance depend largely, not on how the Indian economy does, therefore do not have huge expectations built into the price.

However, the important thing is to not go in all at once but to spread your buying over longer period of six to eight months in equated amounts.

Disclosures:

In the interest of full disclosure, for sectors and stocks mentioned, I’ll clarify any existing holdings of stocks discussed with a quick rationale of current strategy.

Stocks Context & Current action
L&T, BHEL, Voltas, BGR Energy Accumulated through 2013. Currently HOLD only given sharp run-up
TCS, Infosys Accumulated over several years. Currently HOLD on TCS, small monthly BUYs in Infosys
Lupin, Cipla, Aurobindo Pharma, Indoco Remedies Accumulated over two years except Cipla, a new addition. Currently HOLD all except Cipla, which is monthly BUY
Suzlon No position. Would not touch with a bargepole.

References (external links):

What is a cyclical share? (Motley Fool)

Cyclical versus Defensive stocks (Societe Generale)

The case for rotating into (select) cyclical stocks (etfdb.com)

 

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