• by Sayantan Das
• 20th Nov 2020

These 2 Sectors to Emerge as Leaders if Bull Market Continues

Ridham Desai, MD of Morgan Stanley India, says that the sectors that have performed poorly fundamentally and also in terms of stock prices might make a comeback with a better economy.

The nature of the economy is such that every large company, be it IT, pharma or airline, has seen a market share gain. How and why the smallcaps and midcaps are likely to make a comeback?

This market share gain is actually an outcome of subpar growth and the several economic changes that have been undertaken in the last few years. The large companies along with their balance sheets were favored by economic activities like demonetization, GST, RERA, IBC, high real interest rates coupled with slow growth among other activities that helped them gain the market share. In the total market cap, their share and profits are sitting at peak levels.

Many of the painful reforms we saw were quite good for medium-term growth but weren’t meant for short-term growth. Those things have been mostly absorbed through. Moreover, an improving economy might be around the corner. Even the high real rates might come down as it seems that we also got structural inflation under the belt.

It is the exact opposite of the last seven- or eight-years’ situation. If this is the reality, then it would be wise to shift from large cap to midcap. But if this doesn’t happen, then the call might go totally wrong.

What’s more important here is the framework. It can be tested whether the framework is working before making the portfolio call. Mid Caps will perform better than large caps if the framework is working.

Banks being a proxy to the economy, how are they moving? A cyclical recovery is likely to benefit the banks but with the disruptions, what could be the future?

There may be an exception of large versus mid in the banking sector. Large private banks are likely to continue to do well. Public Sector Banks, on the other hand, are suffering the wrath of a capital shortage, which even the government is not taking much interest to increase. They will, therefore, continue to struggle to make flowery balance sheets. Strong liability franchises would be enjoyed by them though. This basically means that they won’t be able to cope up with the pace in which private banks will lend due to their better capital at hand.

The likes of NBFCs, the midsize players, are likely to struggle due to shortage of capital as well as liability franchise. For the banking sector, the concentration story persists. Versus the rest of the market where concentration is likely to dissipate, this may be the differentiating factor for the banking sector.

While the banking sector is the economy’s reflection, economic recovery is lagged by credit growth. The growth can lag by six to nine months and even 12 sometimes. Credit recovery is still pending and is likely to be seen in 2021. This means that they are the sector leading the bull market despite losing their market position. The improving prospects in the economy may push the banks to do well.

The bull market leadership is likely to come from somewhere else like the auto or industrial if it lasts for three or four years. This, however, is unlikely with the concentration remaining with the large private sector banks only.

What is leadership in this market? Is it true that underperformers will become outperformers?

Sectors have a life cycle. This means that no sector can go endlessly. It has been seen that when a sector’s share in total market cap or the leaning indexes approaches 30%, it tends to peak. This has been seen happening in India and might have happened outside as well. But, after a while, the sector would be done and dusted.

The 90s saw this happening to consumer staples and technology. The same happened in the 2004-07 bull market with energy and recently, with financials and IT. When these markets were at the peak, they were somewhere around 30% of the market cap before they began going down. Currently, IT is in the low 20s while financials is in the mid-30s. Both have started a downward trend. At the peak, they were together almost 55-60% of the index. It is unlikely that they will remain there. With the economic growth coming back with the broadening of the economy, some of the sectors that have become 2-3% index after getting decimated in the last 10-12 years will suddenly start becoming 4-6-8%. There are various sectors with poor performance both fundamentally and in terms of stock prices that have the chance to spring back with a better economy. These include consumer discretionary, industrials, healthcare and utilities.

It is sure that one or two of these sectors would lead the market. It’s difficult to predict which one or two it would be though.

With the demand coming back, is a much broader-based recovery going forward likely as we have seen till now that it is difficult for things to move forward without a fiscal stimulus?

A fiscal stimulus is likely not needed because of the momentum in the economy which shall take care of it. The stimulus was a need only for the poorest of the poor who were quite negatively impacted by the pandemic. It has already been taken care of and hence, a stimulus is unlikely needed now. In January and February, the economy already had legs and a multi-year high could’ve very well be seen on GDP growth in June if not for the pandemic.

An interesting space is real estate. This bull market’s genesis is the unprecedented liquidity put into the world by governments and central banks all over the world. This is actually many times bigger liquidity than we saw after the global financial crisis that liquidity found its way into gold and share prices and shall now enter the property as well.

Property, thus, will do well. The inventory will go down first and it may take time for the prices to go up but it eventually will. It shouldn’t be surprising if these people say that their markets are showing some spark because, in the months to come, they are likely to become more robust. If two sectors are to be picked, they should be consumer discretionary and industrials as the sectors people should be watching out for in the days to come.