Earnings variation of cyclical sectors is higher and an improved economic scenario would translate into upward earnings revisions for these companies, which in turn would make the overall Nifty earnings expectations look better. Photo: Aniruddha Chowdhury/Mint
Earnings variation of cyclical sectors is higher and an improved economic scenario would translate into upward earnings revisions for these companies, which in turn would make the overall Nifty earnings expectations look better. Photo: Aniruddha Chowdhury/Mint

As the Indian economy recovers, cyclicals’ weight in Nifty to hit multi-year high

Post April 2018, the Nifty index will have a representation of 39 cyclical stocks and their weight will be 77%, the highest since 2011

The Indian economy is gradually recuperating from the after-effects of demonetisation and the rather chaotic goods and services tax (GST) implementation.

According to Kotak Institutional Equities, a cyclical recovery is on the anvil and an upward revision of Central Statistics Office’s first advance estimate of real gross domestic product and gross value added growth affirms visible signs of an underlying improvement in the economy.

Though economic growth is yet to bounce back to levels seen before demonetisation and GST, a gradual but sustained upturn in the economic cycle would be beneficial for listed stocks in the cyclical sectors including cement, capital goods and infrastructure.

Cyclicals are stocks whose price is affected by the ups and downs in the overall economy.

Interestingly, post-April 2018, the Nifty index will have a representation of 39 cyclical stocks and their weight will be 77%, the highest since 2011 (see chart).

During an economic downturn, investors usually seek refuge in defensive stocks like pharmaceuticals and IT, which are driven more by global factors. Consumer staples, another non-cyclical sector, has very high valuations.

In the recent past, these defensives have lost their sheen due to a combination of company-specific and global factors. So, the anticipated economic recovery could attract investors back to cyclicals.

“During FY11-16, the weights of cyclical stocks (sectors other than IT, Pharma and consumer staples) decreased from 75% to 67% due to their under-performance and the exclusion of three cyclical stocks. Post FY16, they outperformed leading to the inclusion of one additional cyclical stock in April ’18," said a report by brokerage house Elara Capital Ltd dated 27 February.

So, what does this mean for the index?

According to some analysts, earnings variation of cyclical sectors is higher and an improved economic scenario would translate into upward earnings revisions for these companies, which in turn would make the overall Nifty earnings expectations look better.

Elara Capital foresees Avenue Supermarts Ltd and Shree Cement Ltd as the next inclusion candidates at the expense of Lupin Ltd and Bharti Infratel Ltd. Consequently, the weight of cyclical sectors would further increase after September when the next reshuffle occurs, said the report.

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