The sentiment on Dalal Street has suddenly turned sour after nearly a year of bullishness. The benchmark BSE Sensex was down nearly one per cent on Wednesday, its worst show in the last two weeks. With this, the benchmark index is down nearly 2,000 points from its lifetime high made in July.
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The correction was triggered by the sovereign rating downgrade of the United States of America by Fitch Ratings on Tuesday. Fitch Rating downgraded its US debt rating to AA+ from AAA.
A lower rating will translate into higher interest rates or yields on US treasury bonds. The yield on the 10-year US government bond was up 5 basis points on Wednesday as bond investors are now asking for higher yields to compensate for the higher risk involved in investing in US government paper.
Higher yields on US treasury bonds will translate into higher bond yields across the globe over a period of time. This is bad news for asset prices, especially risky assets such as equity.
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The headwinds could be stronger for emerging market assets including Indian equity given the country's large dollar-denominated foreign debt and the big role that foreign portfolio investors play on Dalal Street.
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The Indian equity market also faces headwinds from its extremely rich valuation compared to other developed and emerging markets. According to estimates, the trailing price-to-earnings multiple in India is 40-50 percent higher than in major emerging and developed markets.
Another issue for India is its high public debt to gross domestic product (GDP) equity ratio. In fact, India’s public debt to GDP ratio is one of the highest among the major emerging markets. This is a major growth headwind in a global environment of rising interest and weakening growth impulse.
The general consensus is that the Indian stock market will underperform both developed as well as emerging markets in the scenario. This will keep stock prices in check on Dalal Street and the majority of stocks could see a decline in their prices.
However, as in the past, not all stocks and sectors will move in a similar direction. The risk on the rally in Dalal Street in the last year was driven by stocks in cyclical and high beta sectors such as banking & finance, metals, capital goods & infrastructure, real estate and automotive. This trade is now expected to unwind leading to a sharp reversal in share price in these sectors.
Investors are now expected to become cautious and would prefer capital protection over growth. This will favour blue chips and stocks with strong balance sheets in defensive sectors such as fast-moving consumer goods (FMCG), IT Services and pharmaceuticals and healthcare.
Here investors would prefer companies with little or no debt on their balance sheet, a track record of consistently high and preferably rising return on equity (RoE), free cash flows and a strong position in their respective market.
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Here are five defensive stocks to buy from Nifty FMCG, Nifty Pharma and Nifty IT Index that meet these criteria. These stocks are expected to outperform in a weak market and they could be used to hedge your portfolio from the market volatility.
1. On the top of our list is IT Services export behemoth Tata Consultancy Services (TCS). It has been one of the most consistent performers on the bourses in the last decade and is expected to outperform once again. It has one of the highest RoEs among index stocks at 48 percent, a debt-free balance sheet and is the country's top dividend payer.
2. The tobacco and FMCG major ITC is next on our list with a 3-year average RoE of 25.4 percent and a debt-free balance sheet. Its stock price has doubled in the last three years and it could rise further given the expectation of an increase in its RoE and high dividend payout.
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3. The multinational FMCG major P&G Hygiene is next on our list. The company reported an RoE of 77 percent in its latest 12-trailing months, up from a 3-year average of 63 percent. A high dividend payout ratio and market leadership put the stock in an advantageous position in a volatile market.
4. The Indian subsidiary of Swiss multinational Nestle India is next on our list. The company has one of the highest returns on equity in the listed space with three-year average RoE of 110 percent. This, coupled with its market leadership and big dividend payout, makes it a classical defensive stock.
5. The last stock in our list is the Indian subsidiary of American healthcare major Abbott India. The stock has reported an RoE of 30 percent on average in the last three years, which is among the highest in the pharma industry. The company is also a market leader and among the biggest dividend payers among its peers.
(Disclaimer: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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