Risk-on wallops defensive shares

The ball that the government has set rolling on reforms may knock down the defensives — such as pharma, FMCG and information technology shares — off their lofty perch of the last many months.

Defensive shares or sectors are those that do well even in times of economic distress.

They are amongst the worst performers since the government announcement on reforms.

The BSE Healthcare index is down 2.02%, the BSE FMCG index is down 3.59%, while the BSE IT index is down 3.71% so far.

The Sensex is up 0.17% since the announcements last week, closing at 18496.01 on Tuesday.

Valutions may explain why.

The Healthcare, FMCG and IT indices trade at between 19 to 60 times the earnings of the companies that are a part of them. The corresponding figure for the Sensex is 17.31.

The fall comes after the government announced a let-up in fuel subsidies last Thursday. On Friday there were announcements on allowing foreign direct investments in aviation, retail, broadcast and power exchanges.

Since this coincided with European and American central bank efforts to pump in additional liquidity in the financial system, brokerages have advised a shift towards more ‘risky’ stocks at the expense of these counters.

Nischal Maheshwari, Kapil Gupta and Toshi Jain, analysts with Edelweiss Securities, suggest changing from a ‘sell on rise’ to ‘buy on dips’ strategy.

“We recommend adding beta (risk) to the portfolio through interest rate cyclicals and trimming holdings in defensives such as FMCG and pharma,” they said in a note on Tuesday.

Ridham Desai, Sheela Rathi, Utkarsh Khandelwal and Amruta Pabalkar of Morgan Stanley, in a note titled  ‘Adding to Cyclicals as Market Heads for Life High in 2013’ on Monday said cyclical sectors look cheap compared with their defensive counterparts.

“We go underweight consumer staples and raise energy and materials to overweight, as well as taking industrials to neutral. We are also trimming technology by 100 bps,” they said.

Ajay Bodke of Prabhudas Lilladher said selling in consumption-led sectors is likely due to high valuations.

“These companies saw massive buying in the wake of strong growth characteristics exhibited over the last few years (when investment cycle had come to a standstill) and they were beneficiaries of ‘safe haven’ status,” he said in the report dated September 17.

Key stocks in these sectors, too, have been in the red over the last couple of days.

Tata Consultancy Services(TCS) has dropped 7.9% and ITC is down 5.22%. Wockhardt , Cadila Healthcare and IPCA Laboratories are down 5%-7.5%.

Meanwhile, higher-beta sectors are outperforming. The BSE Power index is up 3.09%, BSE Bankex 3.95%, the Capital Goods index is up 4.67% while the BSE Realty index is up 6.73%.

But earnings may forestall too sharp a decline, according to some.

Murali Krishnan, head of institutional broking at Karvy Stock Broking said defensives still offer the best visibility on growth.

“The announced reforms will still take some time to show effect. Meanwhile the defensives are still outgrowing the market in terms of earnings. People may move out of defensives a little but other sectors and broader markets are still to recover from the structural damage in recent times.” he said.

Swati Kulkarni, vice president and fund manager at UTI Asset Management Company, also did not see an immediate switch though the trend could gain momentum if reforms stay.

“The shift is not a total one, one could see a fair amount of shuffling between sectors...If there is no roll-back and the momentum in reforms continues then the trend away from defensives and towards high beta and cyclical stocks could continue,” she said.