Banking & finance, energy PSUs to be future outperformers

While the Nifty was up by almost five per cent in October, the Bank Nifty index was up 11.9 per cent in the same period. The CNX Finance, which holds six banks stocks in common with the Bank Nifty, along with nine non-banking finance stocks, was up by 9.8 per cent.

The Bank Nifty and CNX Finance together contribute about 28 per cent of the Nifty by weight. The financials were the major driver for the broader index. Among other key sectors, FMCG and IT registered net losses during the past month, while metals, realty and pharma underperformed the Nifty. The super-liquid L-15 index, which consists of 15 Nifty stocks, was also nominally down in the last month.

By definition, the overall trend is bullish and it would be sensible to assume that there would be net gains across the broader market until and unless some clearly bearish indicators are visible. The banking and finance sectors are historically high-beta and likely to continue outperforming the broader market.

The current rally in rate sensitives is predicated on expectations of lower inflation and higher growth in the near future. The consensus expectation is that the RBI will start cutting rates in early 2015. Assuming that inflation does fall as we go forward, the expectation will get stronger.

If there are rate cuts, the rally will get new legs. If there are no rate cuts, there will be a correction in mid-January. But the hopes of rate cuts in March-April will buoy the market up until that time at least, even if there are no rate cuts in January.

Therefore, it would be a reasonably safe bet to focus on banking and finance and hold long positions across that space until such time as the RBI does cut rates. But it is also likely that there will be some sector rotation with other sectors catching up in the near future.

Highly capital intensive sectors such as infrastructure and capital equipment could be one focus area.

If infra projects do restart, construction firms and project developers would receive a shot in the arm. There is a lot of optimism in this area and it would also mean easier conditions and more opportunities for capital equipment manufacturers.

Another possible area for outperformance is that of PSUs in the energy space. The drop in crude and gas prices is favourable to the marketing and refining businesses and by extension, it is favourable for ONGC, OIL and Gail since their share of the (much reduced) subsidy burden also drops.

Defensive sectors like FMCG often suffer neglect when the market is notably bullish. Traders tend to sell these stocks in order to raise money to buy into high-beta stocks that could move faster than the market. So these stocks are very likely to under-perform. It is more difficult to judge the fate of IT and pharma stocks. At one level, these stocks are dependent on a strong dollar and that's quite likely to come about.

At another level, the global consensus is that there will be slow growth across the IT sector over the next year. That may affect Indian IT services firms. Indian pharma companies are still struggling to meet more stringent US FDA regulations. Both pharma and IT may see selective buying. But unless the rupee dramatically weakens against the dollar, neither sector will be a driver for the bull run in the next few months.

The author is a technical and equity analyst