Analysts bet on defensive sectors amid rising inflation concerns

India's retail inflation, according to data released this Friday, surged to a three-month high of 5.03 per cent in February, as against 4.06 per cent in the previous month

Rising bond yields have created a flutter in global markets with investors tweaking their investment strategy and seeking safe-haven plays.

The story back home has not been any different with the S&P BSE Sensex and the Nifty50 indices slipping around 3 per cent each from their respective 52-week high levels. Besides cues from the global markets, the Indian markets have had to deal with inflation concerns amid rising commodity prices.

Over the past few weeks, inflation expectations have risen sharply, given the large-scale monetary and fiscal stimulus by global central banks amid ongoing vaccination efforts. Historically, mild-to-moderate inflation has been good for equities, but not the extreme, analysts say. Despite these headwinds, there are ample opportunities for investors and stock selection will be key.

Among sectors, energy and materials are likely to benefit the most during rising inflation, said analysts at Jefferies. “Capital goods, financials and auto sectors also have high positive correlation with changes in inflation expectations (IE). On the other hand, relative performance of defensives such as staples, telecom, utilities and pharma have the most negative correlation with changes in IE. Overall, rising inflation is likely to benefit value cyclicals the most. These trends are consistent across most regions,” said Desh Peramunetilleke, global head of microstrategy at Jefferies.

India’s retail inflation, according to data released Friday, surged to a three-month high of 5.03 per cent in February, as against 4.06 per cent in the previous month, as petrol and diesel prices rose sharply. Going ahead, experts see prices pressures continuing given the rise in global prices across commodities and the rise in food prices. Those at Barclays peg fiscal 2021-22 (FY22) inflation projections at 4.8 per cent. For H1FY22, they see inflation averaging 5.2 per cent, but moderating to 4.5 per cent in H2FY22.

“The non-food and non-fuel (core inflation) is likely to remain at elevated levels. The rise in inflation could come in the way of economic recovery and can pose a challenge to the Reserve Bank of India RBI in maintaining an accommodative policy stance,” said Madan Sabnavis, chief economist at CARE Ratings.

Commodity cost conundrum

Companies, according to G Chokkalingam, founder and chief investment officer at Equinomics Research, will only be able to pass on the rise in commodity prices only to a limited extent, beyond which, the consumers will start curtailing their purchases. This will be a double-whammy for the companies as they then will face a dip in sales amid rising cost.

“Auto and fast moving consumer goods (FMCG) companies are already bearing the brunt of rising commodity prices and inflation. This may not last long and consumers will give in soon. On the other hand, pharma, information technology (IT), real estate and cyclical sectors are relatively insulated from inflation and commodity price pressures,” he says.

Among key commodities, prices for Brent crude have jumped 82 per cent since the end of October to around $70 a barrel (bbl.) now. In the past one year, Brent has flared nearly 120 per cent. Copper prices, too, have more than doubled in the past year and are trading at their highest level since 2011.

“The commodity prices have shot through the roof and all of this cannot be passed on to customers, which would otherwise hit the fragile recovery. Defensive sectors should continue to be darlings of the investors. In the short-term, cyclicals may outperform, but there are still plenty of reasons to be excited about three – five year growth prospects for software, pharma and consumer,” said Jigar Shah, chief executive officer, Kimeng Securities.