Is this sector the ultimate defence against markets crashes and economic turmoil?

Did I say ‘economic slowdown’? Could there be an economic slowdown in India?

Well, we may not be as dependent on exports as China or other Asian nations. But there's no denying that if a slowdown grips the world, there will be some tremors felt here in India as well. And with Trump's tariffs throwing the proverbial spanner in the works of the global economy, a possibility of an economic slowdown is getting stronger with each passing day.

In such a scenario, it becomes important to take a long, hard look at one's portfolio and try and think about how to minimise the damage from a potential crash.

Flight to safety

One of the most common suggestions is to move a significant part of one's portfolio into a defensive sector like FMCG and let it stay there until the situation improves.

You see, if there is an economic slowdown, people are not going to stop taking a bath, brushing their teeth or washing clothes and utensils, all of which require FMCG products. This makes FMCG stocks the perfect choice during times of economic distress.

However, there is a catch. You need to have the first-mover advantage in order to execute this trade, and everyone else is also thinking along the same lines.

This will eventually push the prices of FMCG stocks higher. So if you are late, you may have to pay a huge premium to get into these stocks and lose your advantage.

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One way to find this out is to assess the valuations of FMCG companies. If they are too expensive, you’re late to the FMCG party and if they are cheap or even fairly valued, you can consider getting in.

Well, the good news is that major FMCG companies such as HUL, Nestle, ITC, Dabur and Emami are all either trading below or close to their long-term price-to-earnings (PE) multiples. This means the risk-reward equation is still in favour of investors if you go by historical valuations.

This brings me to the second question. Are we seeking protection from a stock market crash or an economic slowdown? Will the FMCG trade last a few months where, as soon as the stock market hits a bottom, we will be out? Or will it last much longer, until the economy returns to its long-term growth rate?

Let’s assume the market will crash 30-40% over the next few months. In that case, does it make sense to get into FMCG stocks? Do they have a history of falling less than the broader market during a crash?

FMCG stocks in a market crash

Well, I looked at both the 2008 sub-prime market crash and the 2020 Covid crash to test the resilience of FMCG stocks, and came away impressed.

You see, the sub-prime crash started around January 2008 and continued until March 2009. During this time, the Sensex crashed 60%. And by how much did the FMCG index fall? Well, it lost just 28%.

In other words, ₹100 invested in Sensex would have dropped to ₹40, while ₹100 invested in the FMCG index would have dropped to ₹72. So FMCG stocks did prove to be resilient during the sub-prime crisis.

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Let us move on to the covid crash of 2020, which lasted all of two months. It started in January and was over by March. The Sensex lost almost 40% during these two months. And by how much did the FMCG index fall? Well, it fell by 27%, again a much smaller drop than the benchmark index.

So from the evidence at hand, it does appear that the FMCG index does provide good protection from a stock market crash. It therefore isn’t a bad idea to move some of your portfolio into FMCG stocks or the FMCG index when you anticipate a big market crash.

FMCG stocks in a slowing economy

Now, let us come to the performance of FMCG stocks during economic slowdowns. India's GDP growth faced a lot of challenges in the previous decade, between 2011 and 2020.

Between 2003 and 2010, GDP growth was consistently in excess of 7%, except in 2008. However, it failed to touch 7% in 2011, 2012 and 2013 and was one of the big reasons why the BJP-led government came to power.

However, the double jolt of demonetisation and GST hurt GDP growth badly in 2017 and 2018. And in 2019, when the BJP government came back with an even bigger majority, GDP growth was 3.9%, the joint lowest since 1992. Then of course there was the covid crisis, which caused GDP to contract almost 6%.

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It would be fair to conclude that the period between 2010 and 2020 wasn't great from an economic growth standpoint. Can you guess which sector outperformed the benchmark index during this period?

Yes, it was FMCG. During a decade when the Sensex was up just 2.3 times, the FMCG index was 3.5 times. Individual stocks did even better. Britannia was up 17 times, Hindustan Unilever was up almost 8 times, Marico 7 times, Godrej Consumer 6 times, and so on. So during a decade in which Indian GDP growth slowed down and the Sensex performed poorly, the FMCG index and FMCG stocks outperformed and delivered good returns.

In conclusion, FMCG stocks have proved their resilience in the past, both during stock market crashes and periods of economic slowdown. We are currently facing a situation where there could be both if US President Donald Trump’s tariff wars intensify.

It may thus not be a bad idea to get some portfolio protection in the form of resilient stocks. FMCG stocks could be great candidates for this and are worth serious consideration.

Happy investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. 

This article is syndicated from Equitymaster.com