It has been close to 110 days since the first Coronavirus (COVID-19) case was reported in China. Since then, COVID-19 has shaken the entire world by surprise and it has caused a great deal of turbulence. The stock markets around the world have taken a hit and the portfolios of a lot of fund managers have succumbed due to this pandemic. The Indian stock market has taken the worst of the hit of this pandemic as compared to their global counterparts.
The bears are here to stay for a while and the Indian Stock Markets have lost nearly 26% in just 70 days. Experts believe that it will take the economy at least 6-9 months to recover, some people think that this may be an opportunity to increase their equity allocation. Although the focus for a retail investor should be to maintain surplus liquid funds as well as emergency funds as possible in this situation.
For a retail investor it is quite difficult to choose which stocks to select and which one’s to avoid. We are here making an attempt for our readers to understand the difference between cyclical & defensive stocks and how these stocks perform in various phases of business cycles along with a few examples.
What are CYCLICAL STOCKS?
A cyclical stock means a stock whose prices are most affected by systematic changes in the overall economy. Cyclical Stock follows the four stages of business cycle; Expansion, Peak, Recession and Recovery. These cyclical stocks belong to the companies which sells discretionary items; a category of non-essential items which a customer buys when he has surplus funds with himself. These items are considered as “wants” of a customer rather than “needs”. The demand for such items increases during the booming stage of a business cycle.
Expenses incurred for buying a new car, leisure purposes including vacations etc. are some of the many examples of such discretionary expenses.
Examples and Growth of Cyclical Stocks
The cyclical sector stocks include companies which are involved in building materials, manufacturing chemicals, companies involved in extraction, exploration & processing, auto & auto ancillaries residential construction, restaurants, hospitality, entertainment, asset management companies, financial services, mortgage & property management companies. Thus, during the booming stage the companies which sell these discretionary products and services perform better due to an inflated demand. This increases their profitability margins and cash flows which is reflected in their stock prices.
As the economy grows, the demand in the economy grows for such products and to meet such demand the companies increase their production levels. To meet the new production levels companies employ more people and the overall level of income in the economy grows as well this cycle continues till the economy hits the “peak” and then the vice versa happens. Demand falls, which leads to a lot of unsold inventories, this in turn leads to lower production levels, layoffs, low income level etc. This is known as the declining stage of the economy.
Decline in the Cyclical Sector Stocks
So far we have witnessed a booming stage of the Indian economy post the 2008 financial crisis. The boom came to a halt post a series of bad decisions like Poor implementation of Demonetization, GST, followed by global recessionary trends. The decisions impacted the MSME sector as they were not able maintain their “Cash Cycle” due to a lot of unsold inventories and this led to rising NPA’s, Defaults by NBFC’S etc. The latest incident being the coronavirus crisis has left the economy in a spot of bother and the future looks grim. Here we take a look of the impact of coronavirus crisis on indices which are made up of cyclical sector stocks. There are 5 indices which are considered for our reference. These are NIFTY AUTO, NIFTY BANK, S&P CONSUMER DURABLES, NIFTY INFRA, NIFTY SERVICE SECTOR. The performance for these stocks indices is taken for a period of 6 months starting from November 2019 till mid-April 2020. This time period covers the entire coronavirus crisis from the date the first covid-19 case was tested positive in Wuhan (China).
|S&P CONSUMER DURABLES||Month||Nov'19||Dec'19||Jan'20||Feb'20||Mar'20||Apr'20|
|NIFTY SERVICE SECTOR||Month||Nov'19||Dec'19||Jan'20||Feb'20||Mar'20||Apr'20|
What are DEFENSIVE STOCKS?
A defensive stock means a stock which is stable and performs the same regardless of the overall condition of the economy. They can also be termed as Non-cyclical stocks and they tend of defend the investors wealth during bad performance of stock markets & recession.
Defensive stocks rise during the economic expansion but they rise less as compared to cyclical stocks. When the markets fall, they tend to fall less as compared to cyclical stocks. These stocks represent companies which cater to the “needs” of the public rather than the “wants”. It is very important to have some exposure to these defensive stocks as they “defend” the portfolio of an investor. The correlation of earnings growth and performance of defensive stocks is low as compared to the cyclical stocks. Revenue, profit & cash flow for these companies are consistent.
Examples and Growth of Defensive Stocks
The examples of defensive stocks include companies which produce many customer staples. These include companies which are involved in the production of food items, beverages, utilities like electricity and water, hygiene products, pharmaceutical companies etc.
Fast-Moving Consumer goods (FMCG) are considered as defensive stocks as they cater to all the “needs” of the people. Recently we saw HUL (The Indian subsidiary of Unilever ltd.) entered in the list of top 15 global customer staple stock by market capitalization. Also we recently saw that the stock price of Nestle reached an all time high (INR 17,544.05). This is happening because of the recent stock market conditions and the investors are now placing their bets on defensive stocks.
Coronavirus and the Defensive Stock Bets
Here we can see the impact of coronavirus crisis on indices which are made up of defensive sector stocks. There are 5 indices which are taken as a reference: NIFTY FMCG, NIFTY PHARMA, NIFTY IT, NIFTY ENERGY and BSE PSU. The performance for these stocks indices is taken for a period of 6 months starting from November 2019 till mid-April 2020. Thus, the sentiment of investors reflect in the prices of stocks of various categories and sectors. When the things are in a downturn, the defensive stocks protect your wealth. They too take a hit but the impact is far lesser as compared to cyclical stocks.
What are the market leaders views?
With no end in sight to the lock-downs and all companies financial projections rendered meaningless, investors all around the world are vigilantly fine-tuning their stock portfolios to certify that they can bring safety as well as progress over the longer term. We now take a look at what the market experts from various brokerage houses are saying:
Sanjiv Bhasin, Director at IIFL Securities, said the market would see a change in sectoral leadership after the COVID-19 and the leaders of now may not be in the same position in the future. “OTT and data is the next game plan. There will be a lot of new changes which will come about. There will be a change in market leadership also. New leaders may not be from NBFCs but from some other sectors such as pharma,” he said.
Vinod Nair, Head of Research at Geojit Financial Services, too, has a similar view. “The implication to varied businesses will differ within which some will evolve as a winner as a result of the change in public preference and investment strategy post-COVID issue,” Nair said.
Vikas Jain, Senior Research Analyst, Reliance Securities, is of the view that private banks, pharma and insurance sectors will dominate the markets in the coming years as valuations are reasonable and market share gains in domestic and international markets will incrementally add earnings expanding the PE multiples going forward.
While it cannot be said precisely how the things will pan out after normalcy returns, analysts say “investors should add quality stocks to their portfolio, as the market will see a V-shape recovery after the coronavirus infection comes under control.”