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Safe havens in a bear market

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The last month has seen investors reducing high-risk exposures. The movement to safety has meant two things. First, the focus is more on highly liquid large caps rather than small stocks. Second, even inside the large cap universe, allocations are weighted towards safe businesses, not cyclicals.

The first shift, towards large caps, is quite common in bearish conditions. One of the most important reasons is simply that it's easier to dump a large cap in a hurry. Another related reason is that large caps have higher index correlations and this makes it easier to hedge large cap exposures. A third is that large caps are actually better equipped to ride out downtrends in the business cycle. Bigger balance sheets offer better insulation.

The second shift is also common. The less cyclical an industry, the better its chances of riding out a recessive period. have more stable growth rates. Non-cyclical industries also experience less volatile share prices. They tend to be low-beta and that's a major advantage if the market-wide trend is down.

Unfortunately, the market definition of 'non-cyclical' or perennial, as called such stocks, isn't absolute. Any business has risks and those risks change in magnitude. A few years ago, there were perhaps four industries that counted as low-risk perennials in the Indian context.

One was fast moving consumer goods (FMCG), another was pharmaceuticals, a third was Infotech (IT) and a fourth was hospitality. With the exception of FMCG, the other three were seen as low risk largely because they earned forex. These businesses were seen as largely insulated from ups-and-downs in the domestic space. That perception has changed.

IT has been struggling to maintain growth rates ever since the sub-prime crisis. Most Indian IT firms are over-dependent on the US, and the few that have significantly de-risked from North America are dependent on the euro zone. Both regions are in bad shape. Also, cloud computing has been disruptive to the Indian IT services model.

Hospitality is dependent on overall macro-economic conditions. Forex earnings fall when there's a drop in the numbers of business visitors. Indian pharma does well in high-volume generics. But few have the skillsets and pockets required to develop new drugs and push these through the entire cycle of foreign patents and approvals.

That leaves just as a safe growth area. By default, it's likely to be the only counter-cyclical defensive sectoral play. Dabur, ITC and Hindustan Unilever have already seen outperformance in the recent past. Colgate, Godrej Consumer and Marico, could all pick up steam even if the rest of the market gets weaker. There's a case for being seriously over-weight in the sector.


The author is a technical and equity analyst

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