macromust valuation gap between the cyclicals and the defensives (like IT services and consumer stables) is at its widest since 2008

...St feels it’s time to invest in cyclicals Published: Monday, Oct 22, 2012, 8:14 IST By Sachin P Mampatta | Place: Mumbai | Agency: DNA

Following earnings revisions during October, cyclical sectors such as energy and financials have overtaken defensives like consumer durables, FMCG and information technology in valuation sweepstakes, reflecting expectations that they would have more black ink (higher profits) in their results than red. Some market people argue that this may justify increased buying in cyclicals. More so because the valuation gap between the cyclicals and the defensives (like IT services and consumer stables) is at its widest since 2008. (A ‘cyclical’ business goes through phases of high growth and stagnancy; ‘defensives’ do well even in adverse economic conditions.) The latest issue of Asia Equity Strategy Report of Credit Suisse stated that while “the EPS (earnings per share) revision trend was certainly stronger in consumer staples and IT services over the past 12 months...(there is)... a change over the past three months. So far in October, energy and financials are leading the upgrades to 2012E consensus EPS”. The energy sector received the biggest upgrade (0.9%) in earnings this month, according to Credit Suisse. Financials was the runner-up with the second biggest upgrade of 0.2%. Meanwhile, IT services and consumer staples were both associated with consensus EPS downgrades of 1.1% and 0.1%, respectively, in October. Credit Suisse had previously argued for a switch from the defensives to the cyclicals based on the fact that the price-to-book gap – it is a measure of how expensive a company is on the basis of its assets – between the cyclicals and the defensives in India was bigger than in 2008. Others believe that the defensives aren’t done with their day in the sun. Chokkalingam G, ED and CIO at FCH CentrumWealth Managers, believes that cyclical sectors still have their issues. “On aggregate, there aren’t likely to be any earnings upgrades for the cyclicals, while there may be some upside for the defensives.” But, in a quarterly preview dated October 10, Murali Krishnan, head - institutional broking, Karvy Stock Broking, said some cyclical sectors may show high growth.