How the sectoral indices performed in December 2023?

28 Jan 2024 , 06:53 AM

GENERIC RISK-RETURN VIEW OF THE OVERALL MARKET

The NSE data on its key indices and their valuations is out and the data is both generic, as well as sectoral and thematic. Our focus will be on how the various sectors performed for the period ended 2023 on the parameters of returns, risk, and valuations. However, before we move to the sectoral story, here is a quick look at the macro story of macro indices.

Generic  Index	1-Year (%) Returns	3-Year (%) Returns	5-Year (%) Returns	Volatility Risk	Index Beta	P/E Ratio	P/B Ratio	Dividend Yield
Nifty 50	21.30	17.21	16.24	9.78	1.00	23.17	3.81	1.28
Nifty Next 50	27.24	18.91	14.64	12.40	0.92	25.65	4.29	1.41
Nifty 100	21.24	17.17	15.87	9.80	0.99	23.75	3.91	1.27
Nifty 200	24.66	19.01	16.73	9.76	0.97	23.89	3.88	1.21
Nifty 500	26.91	20.30	17.47	9.65	0.94	24.48	3.91	1.17
Nifty Large Midcap 250	32.66	23.84	19.48	9.76	0.88	25.06	3.98	1.07
Nifty Midcap 100	47.55	31.53	22.02	11.87	0.84	24.65	3.70	0.84
Nifty Smallcap 100	56.66	29.96	19.77	13.86	0.88	28.74	3.74	0.97
Nifty Total Market	27.95	20.91	17.74	9.70	0.94	24.65	3.86	1.15

Data Source: NSE

Let us look at the generic returns first to get the macro picture. In terms of 1-year returns, the Nifty Small Cap index leads the pack at 56.66%, followed by the Nifty Mid-cap index at 47.55%. However, in terms of 5-year CAGR returns, it is the Mid-Cap index that leads with 22.02%. An investment in the Nifty over last 5 years would have yielded 16.24% CAGR.

Let us turn to the risk metrics of the generic indices. Not surprisingly, the mid-cap and small cap indices are substantially more volatile than the other indices. However, this means that they also have the lowest correlation with the Nifty, making the mid-cap and small cap indices, good candidates for diversifying risk and reducing the overall portfolio risk.

Finally, let us turn to valuations of the generic indices. In terms of P/E valuations, the small cap index is the most expensive, while mid-cap valuations are almost at par with Nifty. Interestingly, the Nifty Next 50 has the best dividend yield among the indices. However, this can be a distorted picture as this is more due to the predominance of PSUs in this index.

HOW SECTORAL INDICES FARED ON RETURNS AS OF DECEMBER 2023

The table below captures the key sectors and the returns they have generated across different time frames. The table is ranked on 5-year CAGR returns since short term returns can often be misleading in the case of equity assets.

Sectoral  Index	1-Year  Returns	3-Year  Returns	5-Year  Returns
Nifty Realty	82.02	36.06	28.03
Nifty Metal	19.12	37.31	22.54
Nifty IT	26.30	15.70	22.13
Nifty Consumer	23.69	16.55	18.71
Nifty Oil & Gas	13.10	21.93	17.80
Nifty Auto	48.75	27.80	16.42
Nifty Healthcare	33.99	12.77	16.33
Nifty FMCG	30.78	20.84	15.17
Nifty Pharma	34.76	10.08	14.53
Nifty non-Banks	32.86	15.74	14.08
Nifty Fin Serv	14.31	13.10	13.87
Nifty PSU Bank	33.28	49.95	13.86
Nifty Bank	13.29	16.37	12.75
Nifty Private Bank	14.63	13.61	10.71
Nifty Media	20.29	13.89	-0.60

Data Source: NSE

The table has some interesting takeaways in terms of sectoral returns over time frames.

• While the focus will be on a longer term perspective, let us quickly look at the best performer in the last one year. Realty has been head-and-shoulders over the others in terms of the recovery in housing, while automobiles and pharma are the other star performers in the last one year. Private banks and oil & gas are among the laggards.
• If you take a 5-year perspective, Realty has been the top performing sector with an impressive 28.03% CAGR return over 5 years. The other leaders in terms of 5-year CAGR returns are metals at 22.54% and IT at 22.13%. Financials have lagged based on last 5 year returns while only media gave negative returns; more due to the Zee impact.

What are the key takeaways from the Nifty sectoral returns analysis? Realty has been the star performer across short term and the long term. Financials have struggled over 5 years, especially with private banks facing valuation concerns. It has been a surprising star performer over last 5 years, despite the concerns over the last 1 year. In terms of 1-year returns and 3-year returns; all the sectors have yielded positive returns for investors.

HOW SECTORAL INDICES FARED ON RISK PARAMETERS AS OF DECEMBER 2023?

We now shift focus to the sectoral index risks. We look at risk in 3 parts. The standard deviation or volatility is the simplest method of measuring overall risk of a sector. It measures the extent of variation or deviations from the mean. Beta is more of a systematic risk measure that classifies sectors into aggressive (Beta > 1) and Defensive (Beta < 1). Finally, corelation shows whether the sector is a good diversification idea with Nifty portfolio. Lower the correlation, higher the diversification potential.

One more way to interpret the correlation is by finding the square of the correlation, which gives us R² which shows how much of the returns are explained by Nifty movements. In the case of Bank Nifty, the correlation is 0.85 so the R² is  0.7225. that means 72.25% of the returns of Bank Nifty are explained by Nifty moves. However, for pharma index, the R² is just 0.1369, so 13.69% returns are explained by the Nifty movements.

Sectoral  Index	1-Year  Volatility	1-Year  Beta	1-Year  Correlation
Nifty PSU Bank	25.02	1.44	0.56
Nifty Media	21.86	0.87	0.39
Nifty Metal	21.11	1.38	0.64
Nifty Realty	20.11	1.07	0.52
Nifty IT	17.78	1.13	0.62
Nifty Oil & Gas	15.35	1.03	0.66
Nifty non-Banks	13.39	0.99	0.72
Nifty Bank	12.68	1.10	0.85
Nifty Auto	12.61	0.75	0.58
Nifty Private Bank	12.60	1.09	0.84
Nifty Healthcare	12.06	0.50	0.41
Nifty Fin Serv	12.05	1.07	0.87
Nifty Pharma	11.97	0.46	0.37
Nifty Consumer	10.85	0.56	0.51
Nifty FMCG	10.67	0.52	0.48

Data Source: NSE

We will not get into the nuances of risk adjusted returns but focus on looking at sectors based on the various risk parameters. Here are the key takeaways.

• Volatility is the most popular measure of risk. In terms of 1 year volatility, PSU banks, metals and realty have shown the highest degree of volatility. All 3 sectors are also among the return leaders, so these returns have come at the cost of higher risk. In terms of low volatility, sectors like consumer durables, FMCG and pharma are obvious.
• Another way to look at risk is the Beta. While volatility measures the overall risk (comprising of systematic and unsystematic factors), Beta measures the systematic risk that cannot be diversified away. The argument is that the market will only compensate for systematic risk since that cannot be diversified. The sectors with the highest Beta are PSU banks at 1.44. metals at 1.38 and IT at 1.13. These are highly aggressive sectors. Beta of 1.44 means that for every 1% move in the Nifty either way, the PSU Bank index moves 1.46%. On the downside, the lowest Beta are healthcare at 0.43, FMCG at 0.61 and Autos at 0.79. These are substantially less vulnerable to the Nifty moves and while others are expected, auto being low beta is rather surprising.
• We finally move to correlation of the sector with the Nifty or how much of the returns are explained by market factors. The financial services sector overall has a very high correlation with the Nifty while healthcare, realty and FMCG have he lowest correlation. That means a lot of returns on financial services is explained by the macro factors while it is a lot more sector specific in case of healthcare, realty and FMCG.

The bounce in PSU banks and metals has come at the cost of higher volatility. However, IT is a surprise inclusion in the high beta pack and this could be largely attributed to the recent volatility in IT stocks due to the global swings in IT spending.

HOW THE SECTORAL INDICES STACKED UP ON VALUATIONS 

Finally, we look at how the sectoral indices stack upon valuations. Obviously, the P/E ratio is the most popular and we cannot miss that out. However, P/BV has a lot of importance for banks and other sectors that are either in losses or have long gestation periods. Dividend yield is normally more useful at a macro market level but they can give good insights when combined with the P/E ratio and the P/BV ratio.

Sectoral Index	Price/Earnings  (P/E Ratio)	Price / Book  (P/BV)	Dividend  Yield
Nifty Consumer	68.63	9.83	0.44
Nifty Realty	50.39	4.98	0.28
Nifty FMCG	45.81	11.81	1.79
Nifty Healthcare	38.86	5.08	0.63
Nifty Pharma	33.91	4.59	0.78
Nifty Metal	33.65	2.34	2.74
Nifty IT	29.74	7.71	2.33
Nifty Auto	26.33	5.33	0.90
Nifty non-Banks	20.34	3.59	1.01
Nifty Fin Serv	18.63	3.36	0.78
Nifty Private Bank	18.45	2.86	0.60
Nifty Bank	16.60	2.81	0.76
Nifty Oil & Gas	8.20	1.71	2.66
Nifty PSU Bank	8.11	1.32	1.86
Nifty Media	0.00	2.55	0.41

Data Source: NSE

Here are some of the key takeaways from the three valuation parameters and how the various sectoral indices stack up on valuations.

• What are the most expensive by P/E ratio. Consumer durables are at the top with an average P/E ratio of 68.63X; followed by Realty at 50.39X and FMCG at 45.81X. Compared to September, the P/E valuations of these sectors have gone up further, which can be attributed to the frenetic rally in the frontline stocks in December 2023. FMCG and consumer durables have traditionally commanded high P/E ratios on non-cyclical earnings, although FMCG also has the advantage of brands and intangibles, which most other sectors cannot boast of. Realty may be showing the first signs of concerns as the rally has been much sharper than the earnings growth in the last few years. In terms of low valuations, PSU banks continue to trade at a P/E ratio of 8.11X while oil trades at 8.20X. However, both these sectors have traditionally commanded low valuations in the market and single digit P/E ratio has been the norm. That is more due to the cyclicality and vulnerability to the government using them to deliver subsidies to the general public.
• We now move to rankings on P/BV and here again it is the likes of FMCG, consumer goods, IT and healthcare that trade at very high levels of P/BV. However, this ratio has to be used with a pinch of salt. In fact, this Price to book (P/BV) ratio is most relevant to banks and that is where the dichotomy is the maximum. For instance, NBFCs are trading at P/BV of over 3.59X while private banks are trading at 2.86X price to book. In comparison (despite the sharp rally in the last couple of years), the PSU bank index is still very reasonably priced at just 1.32X price to book.
• We finally turn to dividend yield which is arrived at by dividing the rupee dividend by the stock price. Metals, IT, oil & gas, and PSU banks are offering the best dividend yields as a sector. IT has seen a spike in dividend yield in recent years as companies are now more inclined towards more generous distribution, and their dividend yield is over 2% on an average. In the case of oil & gas, it is more due to government pressure on PSU oil companies to dole out larger dividends to boost the revenues of the government. Finally, which are the sectors with the lowest dividend yields. Realty, consumer durables and private banks are at the bottom of the heap as dividends are just not in sync with the growth in stock values. Clearly, in these cases, the price run up has been disproportionate with what the company distributes to its shareholders and that calls for caution on the part of investors. However, dividend yields are best for macro view.

What is the underlying story emerging from the overall ranking of sectoral funds? PSU banks and metals have done well in terms of returns, but also have valuations in their favour. However, risk is high in both these cases in terms of volatility of returns. However, several sectors appear to have run ahead of valuations. But the, who is to argue with bulls in a bull market?