When bulls are highly confident, there tends to be large net inflows of cash into the secondary stock market. Share prices are bid up across a wide variety of sectors at the same time. When bulls are less confident, rallies are more selective. Traders then try to generate investible funds from within the market itself.
In such situations, money is pulled out of sector A and pumped into sector B. After some time, profits are booked in B and the cash deployed in sector C. Then the money moves from C to D and so on. This way, the net cash inflow into the stock market is less but the velocity of the money deployed ensures prices move.
Share prices gain and correct in rotation, as money moves in and out of sectors in this way. Usually, in a sustained bull run, prices in most sectors see net gains. But there will be sharp sector-specific corrections, as profits are booked and rotation occurs. Sector rotation is therefore, normal at some stage in a speculative rally. Money usually moves out of staid low-beta sectors into high-beta sectors first and then moves through various high-beta sectors. One low-beta sector usually an early target for exits is the fast moving consumer goods (FMCG) segment.
This rally seems to be following the classic pattern. Major indices like the Nifty are up about four per cent over the past month. The FMCG index is down by two per cent in that period. In fact, last year as a whole saw underperformance by the sector, up around 13 per cent versus the Nifty's 17 per cent. The major loser in the short term has been ITC (down five per cent in the past month) and Hindustan Unilever (HUL), down about one per cent.
FMCG is generally viewed as the safest defensive sector. Blue-chips like HUL, Dabur, ITC, Colgate, Proctor & Gamble, Britannia, Godrej Consumer, Emami and so on are among the best long-term performers in the Indian stock market.
In mature markets, FMCG stocks are perennials, since these businesses have stable demand even in recessions. In India, FMCG is actually a growth area and likely to remain so. This is partly due to rising incomes creating larger markets and partly due to better infrastructure allowing greater geographical reach. FMCG also tends to deliver high return on capital and, by and large, balance sheets tend to be low-debt. In addition, they pay dividends in predictable fashion.
A comparison with the Nifty shows how strong FMCG performance has been across the long term. Over the last five-year and 10-year periods, the 15-stock FMCG index has returned respective CAGR of 28 per cent and 21 per cent. In comparison, the Nifty has a five-year CAGR of 17 per cent and a 10-year CAGR of 14 per cent. The average FMCG dividend yield over 10 years is 1.6 per cent. The average Nifty dividend yield is 1.4 per cent - not so much difference but it shows up in compounding.
The FMCG index receives price to equity (P/E) discounts in the range of 32-plus ( the average over three years). The lowest FMCG index valuation has been around PE 27, while the highest have been above 42PE. The current PE of the FMCG index is 35.5. The Nifty has run through a minimum-maximum valuation range of PE 14-25 in the same three-year period, with an average PE of 18.5. The current PE of the Nifty is 19. The difference is stark - the lowest PE valuations for FMCG are higher than the highest valuations of the Nifty.
The current rally could see the rest of the market catching up to some extent in terms of valuations. If FMCG is pushed down further, it would start looking like a very attractive buy again. Or, if the bull run stutters or fails, a lot of money is liable to flow out and enter FMCG again, as its defensive nature would be highlighted. Either way, the sector could perform as a counter-cyclical for the next several months.
