Why sector is crucial for stock market investments?

Investors tend to underestimate the importance of sector before investing in a stock. They generally concentrate on stocks but forget about the importance of sector. Investors in IT and sugar stocks missed to capitalise on the glorious bull run in 2007. Except in rare instances, even good stocks in bad sectors will underperform while bad stocks in momentum sectors generally outperform due to positive sentiment. Just see how even good commodity stocks are now falling to unreasonable levels. In USA, many waste management stocks are now trading near 1-year highs.

Investors in power sector got bumper returns in the December, 2007 rally. Textiles are the hot stocks in early 90’s, while IT stocks are the hot ones in late 90’s. Metal stocks are star players in 2007 while they are the worst performers in 2008. When sentiment turns to negative in a sector, even strong fundamentals will not save good companies from free fall.

Why sector is so important?

1. 2001: Nifty gave -16% returns while top sector, Auto, gave 29% returns. Hero Honda was a star in those days.

2. 2002: Nifty gave just 4% returns while top sector, Energy, gave 74% returns and Metals and Banks gave 50% returns.

3. 2003: Nifty gave 74% returns while top sector, Metals, gave 238% returns. Real Estate and Capital goods gave 170% returns.

4. 2004: Nifty gave just 9% returns but top sector, Real Estate, gave 144% returns. Telecom gave 63% returns.

5. 2005: Nifty gave 36% returns while top sector, Real Estate, gave 290% returns. Capital goods stocks gave 110% returns.

6. 2006: Nifty gave 40% returns but top sector, Real Estate, gave 200% returns. Metals and Telecom gave 70% returns. Unitech and Bharti Airtel investors may not forget those days.

7. 2007: Nifty gave 55% returns while top sector, Metals, gave 190% returns. Capital goods and energy stocks gave 110% returns.

8. 2008: Nifty gave big negative returns but investors in FMCG and sugar stocks escaped from big losses.

Statistical source: Business Line.

I am requesting readers to share their views and data on the importance of sector. I am eager to see which sector will outperform in 2009. Will alternative energy finally take lime light? Will commodities bounce back? Will defensive sectors like Pharma and FMCG continue to rule?

My GDP estimate: Indian GDP growth will fall to 6% in this financial year from 9% in the last year.

About valuations: Analysts are talking about historically low valuations of BSE Sensex and NSE Nifty but such assumptions will not work in the current market. When BSE Sensex was trading at P/E of 14, it was trading at a forward P/E of 10-12. There was an investment opportunity at that time. Now Sensex is trading at an attractive P/E of 10-11 but it is now trading at a forward P/E of 14-15. There lies the problem. Future growth is very important in stock markets. Very few companies will positively surprise us the next quarter results. Fall in consumption will offset the fall in commodity prices and interest rates.

Global recession news: Developed countries are gradually slipping into deep recession and these economies will take years to recover. Reviving economy is not going to be as easy as Obama said. It is no longer about “sub-prime crisis”. Crisis spread to main economy and families are now really feeling the heat. Job losses are aggravating the problem.

1. Citi Bank will cut another 52,000 jobs to reduce work force by 20%. The bank already cut 23,000 jobs in this year.

2. Europe: Continent is officially in recession after 15 years. All the European countries are showing negative growth.

3. Japan: Unexpected shock. Japan GDP growth shrank by 0.4% in Q3. World’s second largest economy went into recession for the first time since 2001. Japan’s public debt is 180% of GDP while USA public debt is 300% of GDP. When will these developed countries recover?

4. Hong Kong: Country is in technical recession which will see more negative growth by next quarter.

5. England: Recession in U.K is painful and prolonged – British Chambers of Commerce. 30 lakh people will become jobless by 2010. Britain economy will shrink by 1.7% in 2009. 18 lakh people are now unemployed in U.K.

6. USA: Retail sales recorded biggest monthly decline since 1992. Auto sales fell by 32% in October to the lowest level since January 1991.

ATF price cuts:

Even though ATF price cut is good news for Airlines industry, it will not change the industry’s business prospects. Airlines problems are mainly due to rapid slowdown in economy and the consumption power of people but ATF price is a minor problem. Can you invest in IT stocks due to dollar appreciation? Can you put your money in textile stocks due to rupee depreciation? Can you invest in Oil marketing companies due to short term fall in crude oil prices? Can you put your hard earned money in Real estate stocks due to RBI rate cuts? Can you invest in Aviation stocks due to ATF price cuts? Give importance to business fundamentals but not to minor happy news. These little things are meant for traders.

About IT stocks:

This sector is seeing dramatic collapse in the last 10 days. Current decline in IT spending is much deeper than estimated. IT research firm IDC revised world IT spending growth estimates to 2.6% from 5.9%. India will be severely impacted by this drastic slowdown in IT spending. Intense competition for new orders among companies will dent their profit margins. Investors should stay away from this sector until January. Intel, Cisco, Apple, AMD, Google and Nokia shares are plummeted in NASDAQ. IT industry lost 7,00,000 jobs in 2001 and it will lose 2,00,000 jobs in 2008 and more in 2009.

Read this article to know about the historical collapse in IT spending. I failed to understand that why Infosys and NASSCOM bosses are issuing careless statements about IT spending.

About Real Estate stocks:

Sector is in complete mess. Real Estate companies failed to understand the seriousness of the problem. DLF and Unitech cut 1,000 jobs and put some projects on hold. DLF cut price for square feet from 3,500 to 2,775 at its proposed maiden gated project in Bangalore. Is it enough? Companies asked banks for restructuring of loans. They paid unreasonable money to acquire land banks and are now asking banks for restructuring of loans. Why don’t they build homes at affordable rates and continue their growth prospects? Government should not bailout these companies. German based Hypo real estate announced $4 billion loss in Q3 results. We will hear such shocks from real estate companies in the next 2 quarters. There is so much opportunity for middle class houses in India. Who will spot and grab it without becoming greedy?

Investment advice:

Investors should stay away from stocks of the companies which depend on developed economies for their business growth. Investors should not believe in the statements of Company CEOs. Believe in your intuition and research. I don’t believe in the domestic consumption theory. Indian consumption will fall drastically in the coming months due to job losses. Indians so far felt only 30% of the crisis effects. Real picture will unfold in the coming days. Invest in companies which depend on Government spending, necessary consumption like Pharma and companies which can continue their growth prospects. Many people are concentrating only on IT job losses by forgetting the lakhs of job losses in unorganised sectors like Textiles and Jewellery etc.

Investment strategy:

Short-medium term investors should monitor situation on day to day basis. But long term investors with 2-3 year perspective should accumulate on every fall. Accumulate only good stocks with strong growth prospects and sound business models. But current market is ideal for traders and short term investors. Note down stocks which are actively participating in bear market rallies. Closely monitor them to make 20-30% profits on every rally. Is it not enough?

How I use online trading: I have online trading accounts with ICICIdirect, Reliance Money and Religare.

1. ICICIdirect:

This is for pure long term investments in emerging companies. I will not sell these stocks except in rare circumstances. These companies will not give you any significant returns in the next 1-2 years but even 1-2 successful investments will give outstanding returns over long term. Among these emerging companies, some companies (MIC Electronics and Time Technoplast etc) disappointed me in the recent quarterly results while some companies announced encouraging results like Compact Disc, XL Telecom, Tanla and IKF etc. But I will not sell even bad performers but reduce future investments in those stocks. These are buy and forget type of investments.

2. Reliance Money:

I will use this for medium to long term investments. I am now using accumulation strategy for these investments. Due this strategy, I missed big profits in short time in Educomp, Core Projects and Kalindee Rail Nirman etc while I escaped from big losses in Balasore Alloys and Visa Steel etc due to this accumulation strategy. I will continue to accumulate on every fall. I will sell these stocks if I find something is seriously wrong with the company. I treat every fall in the stock price of a good company as an investment opportunity but not as a selling sign. In these days, things are changing on a daily basis. So you need to monitor your investments and exit bad stocks. Buy and forget is not good in these unpredictable times. Stock selection will depend on your profile.

3. Religare:

I use this for ultra short term opportunities. I bought and sold Larsen and Toubro, JP Associates and Punj Lloyd etc at least 5 times in the last 3 months. But I have not sold single share of Larsen and Toubro in the Reliance Money account. That is the difference. Enter into the stock if you spot an opportunity and exit with reasonable profits. Greed is very dangerous. If you are an experienced investor, you should not miss these opportunities.

Suggestion: I am saying above things to suggest that clarity is most important in any investment especially in stock markets. One should invest according to their age, risk profile, needs, expectations and income etc. HUL is a good stock for conservative investors while it is bad scrip for young long term investors. Gujarat NRE Coke, Tata Steel and Hindustan Zinc are bad stocks for short to medium term investors due to commodity slowdown but they are must buys for contra long term investors. XL Telecom, Educomp, Compact Disc, Tanla, ICSA and Bartronics are not good scrips for short to medium term portfolios but educated long term investors should accumulate them.

Investors should analyse their needs and risk profiles and made investments in those stocks that suit their requirements. I am strictly against investments in derivatives especially in futures. Retail investors should stay away from investments in futures and other speculative activities. This is my sincere advice.

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