What are the kind of stocks/sectors one should be buying now?

The three phases of the bear market made most investors move away from capital good, real estate, infrastructure, financial etc stocks into defensive bets like FMCG, Pharmaceuticals, Utilities etc. By the middle of March 2009 these stocks dominated the portfolio of most funds and cash position in funds went up to very high levels.

As despair reached its depths the stocks markets globally started recovering from Early March. The policy actions taken by governments globally in easing monetary policy, making more money available through various programs, the start of quantitative easing i.e. printing of money and also the passing of stimulus packages all over the world resulted in confidence returning to stock markets globally. Economies all over the world also started stabilizing and the downward spiral in economic performance seems to have been broken for now.
Coming to India specifically we have seen signs of stabilization and growth starting in sectors like automobiles, consumer durables, cement etc. Steel consumption has also stared moving up due to greater execution of infrastructure projects. The economic performance seems to have bottomed out in India in January 2009. Liquidity scenario has undergone a sea change and as on today bulk deposit rates which had gone up as high as 13-14% in the last few months of 2008 have come down to 5-6%. Consumer sentiment has also started to stabilize and revive.
Global liquidity has also improved where both LIBOR rates as well as corporate spreads have contracted significantly over the last three months. This will also reduce the cost of refinancing of Forex loans.
Under the circumstances it is important for investors to revisit their investment strategies. The few strategies that should work over the next few months are as follows –

Reduce positions in defensives – This is clearly the time to move out of defensives like stocks in the FMCG, Pharmaceuticals and Utility sectors where companies have outperformed over the last 15 months mainly due to risk averseness despite the fact that earnings growth prospects of such companies are nothing great and valuations of such companies have reached levels which are nearly twice that of market valuations. As fear reduces and things look more benign there is likely to be a movement out of such stocks.

Increase exposure into commodities – Commodity stocks have taken a severe beating over the last few months due to falling commodity prices. Some commodities which are likely to be in surplus are still likely to remain subdued. However this is the time in which a phased build up in commodity stocks should make sense. With the kind of money that is getting pumped into the global economy combined with the imminent fall in the value of the dollar should result in commodity prices moving up. Although it is extremely unlikely that commodities will reach their 2008 peaks anytime soon, commodity stocks normally follow underlying commodity prices and as such a sector like steel, which should see prices bottoming over the next few weeks, should be a sector to watch. Similarly a sector like sugar where sugar stocks saw their peak nearly 18 months before the peaking of the overall markets should also do well. This sector has failed to perform due to perceptions of government intervention should do well post elections.

Financials – Over the last few months among the financial stocks, banks with a large retail base and specifically PSU banks have outperformed due to them getting a greater share of deposits in the turmoil of the last quarter of 2008. Private sector banks and NBFC’s got battered due to higher perceived NPA’s and both the lack of availability of liquidity and the high cost of money. Now with liquidity no longer being a issue and the system being flush with liquidity along with bulk cost of deposits falling much below retail deposit costs there is likely to be an inversion in performance where Private sector financial institutions and NBFC’s should outperform.

Infrastructure companies – Over the last few months stocks of infrastructure companies which includes construction companies have taken a sharp beating. This has happened even to companies with large order books. This was mainly due to perceptions on risk of execution of projects, cancellation of projects and slower execution due to poor liquidity conditions. The order book accretion of such companies was also likely to suffer due to the slowing economy. However prices of stocks in this sector have now fallen to just about 15-25% of their peak value and offer lot of value for medium term investors.

Companies with large forex loans – Stocks of companies with large forex loans, FCCB’s outstanding etc. have got severely battered over the last one year due to the depreciation of the rupee, rising cost of forex loans and refinancing risks. These companies have been reporting forex losses continuously over the last few quarters. Due to the postponement of AS11 guidelines and expected appreciation of the rupee going forward such companies can outperform.

Alternative energy companies – With easing liquidity and bottoming out of crude oil prices, combined with clean energy investments proposed by the new administration in the USA we should see such companies coming back in focus. Stocks of such companies have come down to 10-15% of peak prices.

Automobiles – I am very positive on this sector as we are likely to see strong volume growth revival as well as margin expansion in this sector. This should be a big outperforming sector over the next two years. With consumer financing easing out, the economy reviving and interest rates starting to fall this sector is well placed.

Mid cap stocks in general – Today if one looks at companies on the large cap side (specially that are perceived to be the bluest of blue chips), taking an illustrative example of Reliance Industries the stock price is today 55-60% of its peak value, similar is the case with Bharati Telecom. Most defensive large caps like HLL, ITC are still trading near their peak prices. However today we see a phenomenon where a large number of mid cap companies with extremely robust business models, strong managements, strong cash flows, good profit growth have come down to 10-20% of their peak values. This is not restricted to high risk companies like those of the real estate sector but to a majority of mid cap companies. Out of the universe of nearly 1000 investable mid cap companies one can find at least 20 that can be multibaggers from here on. Incidentally to be multibaggers they just have to go to 50% of their peak values.
Hard work and proper due diligence done in this segment will give the maximum returns over the next two years.

Prologue – As pessimism reached its peak the stock markets globally have recovered sharply from the beginning of March. The MSCI Emerging Market Index is up 38% from its bottom. In India the NIFTY has also gained around 40% from the bottom and the Mid cap indices have also risen by a similar amount.

The thing to remember while investing is that “Money is made by investing when the perception of risk is the
highest. At such times the actual risk of investing tends to be the lowest and the bridging of this gap is what makes money”.