Is this a good time to invest in interest rate-sensitive stocks?

Don't get carried away by the current rally; be picky and take a stock-specific approach

The surprise interest rate cut by Reserve Bank of India (RBI) Governor Raghuram Rajan last week sparked a rally in rate-sensitives. Banking, automobiles and realty stocks rose by up to 18 per cent on Thursday after RBI cut the repo rate by 25 basis points to 7.75 per cent.

Is this the right time to bet on these sectors? The cut is expected to revive consumption and spur credit growth. Besides, analysts expect reduction of another 50-75 basis points in the coming months, if both inflation and the fiscal deficit situation remain under control. Since banks are a play on the health of the economy, they are likely to be a direct beneficiary. However, one has to be picky as these stocks are not cheap and the BSE Bankex has posted gains of 75 per cent in the past year.

“It may be a good idea to shop for quality public sector banks (PSBs) at this point. While many private sector lenders are trading at 2.5 to three times book value, PSBs are trading at one or less than one time book value,” said A K Prabhakar, an independent analyst. He added the worst seemed to be over for PSBs and their asset quality was likely to improve in the coming quarters.

The automobile sector might also see better days ahead, with the rate cut coming on the back of falling raw material prices of steel, aluminium and rubber. “Even a small decline in equated monthly instalments can significantly alter a customer's decision to purchase four-wheelers, so auto sales are likely to get a boost from the rate cut,” said Narayan Shroff, director (wealth and investment management) at Barclays India. Analysts expect auto sales to pick up after June. The surge in demand, however, will be restricted to four-wheelers and trucks, as the ticket size for purchasing two-wheelers is small and not impacted by interest rate cuts.

The decline in inflation will bring down labour costs for automobile firms to some extent, leading to cost optimisation. Auto component makers with adequate capacity are also likely to benefit.

Apart from direct investing, investors can look at mutual funds to invest in interest rate sensitives.

Look at equity diversified funds with 20-30 per cent exposure in financials and 5-10 per cent in automobile companies. Banking sector funds are another option, provided the investment is restricted to 10-15 per cent of one’s equity portfolio. According to Manoj Nagpal, managing director and CEO of Outlook Asia Capital, one must use a target-based exit strategy for these funds. For example, Nagpal says, exit on gains of 40-50 per cent or on a rate cut of 50 basis points (bps).

Stay away from realty stocks, however. Many realty firms have high debt on their books with huge inventory build-up. “Realty prices have moved up exponentially in the past few years and property is beyond the reach of urban middle class. Until prices come down, demand for home-buying is unlikely to pick up in a hurry,” said Prabhakar. For sentiments to improve, a rate cut of at least 100 bps is necessary, he added.

In the past year, the BSE Auto and BSE Realty indices have surged 59 per cent and 21 per cent, respectively.