Identifying Opportunities in the Stock Market
7 May 2023
The global economy is always experiencing significant changes, and understanding macro cycles is key to identifying investment opportunities. In the past 13 years leading up to 2021, defensive sectors such as Fast-Moving Consumer Goods (FMCG), Pharmaceuticals, and Information Technology experienced significant growth, while cyclical sectors, including Metals, Capital Goods, Power, Infrastructure, and Public Sector Enterprises (PSU/PSE), struggled to perform. However, these long-term cycles have now reversed, presenting new opportunities for savvy investors.
The study of macro cycles allows us to determine sectors that are likely to outperform compared to the broader market. Outperformance, in this context, refers to sectors or stocks that experience greater growth during bullish periods and exhibit greater resilience during bearish periods. These sectoral trends can be correlated with bond yields, currency fluctuations, and movements in commodity prices.
Interest Rates vs Sectors
In the past from 2008 till 2020, when the 10-year Bond Yields globally were falling, defensive sectors were on the rise and were out performing compared to cyclical sectors. Conversely, as the bond yields began to increase globally from 2021, cyclical sectors, primarily comprising of old economy stocks, have gained traction compared to defensive plays.
Example of correlation between Bond Yields and Sectoral Performance
When bond yields fall, defensive sectors thrive and cyclical sectors underperform. The chart below shows performance of Nifty FMCG (defensive sector) vs Bond Yields:
Currency vs Sectors
Defensive sectors tend to do well during a rising USD/INR exchange rate. Which was the trend from 2008 to 2020. As we now anticipate a reversal in this trend, with the INR expected to gain value against the USD, old economy stocks are bound to benefit.
Example of correlation between Currency and Sectoral Performance
When the USD appreciates against the rupee, defensive sectors thrive and cyclical sectors underperform. The chart below shows performance of BSE Capital goods (cyclical sector) vs USD INR:
Commodities vs Sectors
An additional indicator supporting the shift from defensive sectors towards cyclical sectors is the Bloomberg Commodities Index. Historically, when commodity prices rise, as they currently are, defensive sectors are outperformed by cyclical stocks, which are capital-intensive and driven by raw material prices.
A prime example of these macro cycles in action can be observed in the Information Technology sector. Over the past two decades, this sector has experienced various stages of the business cycle.
A timeline of the IT sector's progression:
1996-00: IT Sector Euphoria
2000-02: Dot-Com Bubble Burst
2003-08: Consolidation & base building for next bull market (so even though the IT sector rose from 2003-07, other cyclical sectors did much better).
2008-22: Structural Bull Market for IT (supported by the perfect global macro economic environment of interest rates falling, commodities falling and USD gaining strength against the Indian rupee).
2022-24: IT has already shown significant signs of cracks in its system with industry wide layoffs and sudden large drops in stock prices. In our analysis, it has yet to reach its final descent to the trough phase. We believe this sector will go through a repeat of the 2000-02 cycle, where it experienced a severe crash and cyclical stocks substantially outperformed the market.
The chart below shows performance of Nifty IT (defensive sector) vs Nifty Metals (cyclical sector):
From 2007-2020, the Nifty Metals Index experienced a severe bear market - almost a 70% decline over 12 years. During the same period, the IT sector went through its strongest bullish run rising over almost 800%!!! But this trend in our opinion has already reversed and we expect Nifty Metals to significantly out perform Nifty IT in the coming years.
By understanding these macro cycles and making informed choices in sectors and stocks, investors can capitalize on these shifts and multiply their money in quality stocks over the next 3-4 years. The key is to stay vigilant, adapt to the changing landscape, and seize the opportunities presented by this reversal of long-term cycles.
CFP Panna Bhandari
CA Sharad Daga