July 2024 – How sectors fared on returns, risk, and valuations

6 Aug 2024 , 09:04 AM

MACRO INDEX STORY FOR JULY 2024

The NSE has released the index-wise performance for key sectoral, generic, and strategy indices for the month of July 2024. Apart from returns analysis for different rolling periods, the risk factors (volatility, Beta, covariance and R²) and valuation parameters (P/E, P/BV, and dividend yields) are also covered. This gives a 360-degree view of sectors and themes; updated as of the end of July 2024. It answers questions like are sectors compensating you for risk? It also tells you if the risk-return trade is supported by attractive valuations. Above all, it tells you the sectors and thematic stories that have stood out over different evaluation periods. Here is a quick dekko at what we read from the monthly sectoral data.

7. For the month of July 2024, the one-month returns were dominated by the Nifty Micro cap index delivering over 7.8% and the mid-cap delivering over 6.1%. Small caps and the Nifty overall did not really disappoint. Both delivered returns in excess of 4% for the month. Remember, July 2024 was the month when the Nifty made the move from 24,000 to 25,000; which is a key resistance level for the Nifty index.
8. Let us quickly turn to how the thematic ideas performed in July 2024. The Nifty 50 Shariah Index delivered the best thematic returns of 11.47% in July 2024, while the NSE CPSE Index also delivered double digit returns. Defence theme delivered just under 5% in July 2024, but over the last one year, it is still the star performer with 159% returns. In terms of business groups, there was a turnaround with the Tata group outperforming the other major business group in July 2024, in contrast to June 2024, when the Tata group stocks had been an underperformer. If you look at themes over a 5-year period, then in CAGR terms, Defence is still the dominant theme delivering 63% returns.
9. Let us turn to how the various strategy indices performed in the month of July 2024? Growth Sectors-15 was the only theme to generate double digit returns in July 2024. It is rather surprising, but the second best theme was the dividend opportunities theme. Over a 1 year period, Value remained the dominant theme, delivering more than 80% returns; while over a 5-year period, both the Alpha theme and the Momentum theme delivered closer to 40% returns on CAGR basis. When it comes to sustainable returns, growth and aggression is still the name of the game.
10. Finally, what about the performance of the various sectors in the month of July 2024? Once again, the month was dominated by the IT sector, which delivered 13.14% returns as IT emerged as the best bet for investors looking to play the dollar strength. The other top performers among sectors in the month of July 2024 were Pharma at 10.61%, FMCG at 9.45%, and Oil & Gas at 8.47%. On a 1-year basis, realty has still delivered the best returns of 93.53%, followed by Automobiles at 71.1%, and oil & gas at 64.1%. Over a 5-year long term returns measure; realty, auto, and metals have been the star performers.

What we have looked at above is a very short term view to understand momentum and the swing factor in the month of July 2024. Just for the sake of perspective, we have also looked at 1-year and 5-year returns to understand if the outcome is any different. However, if we have to look at a sectoral picture, there are two more aspects we need to focus on, apart from returns. We are talking about risk and valuations!

• HOW SECTORAL INDICES FARED ON RETURNS IN LAST 1 YEAR?

The table captures the key sectors and returns generated across different time frames. The table is ranked on 1-year returns up to July 31, 2024.

Sectoral Index	1-Year Returns	3-Year Returns	5-Year Returns
Nifty Realty	93.53	40.52	33.02
Nifty Auto	71.14	39.67	32.67
Nifty Oil & Gas	64.12	28.42	26.21
Nifty PSU Bank	61.24	46.53	22.83
Nifty Pharma	46.15	15.62	23.14
Nifty Consumer Durables	45.70	19.15	23.40
Nifty Healthcare Index	44.57	16.33	25.05
Nifty Metal	42.38	20.17	31.88
Nifty IT	39.30	12.44	23.64
Nifty Non-Banks	32.56	15.84	16.78
Nifty FMCG	20.12	22.00	18.42
Nifty Financial Services	16.24	13.43	13.78
Nifty Bank	13.94	15.13	12.92
Nifty Private Bank	10.73	13.41	10.58
Nifty Media	4.67	6.89	2.65

Data Source: NSE Indices

The table may look like a melee of numbers, but there are some interesting takeaways. To begin with, the good news is that 1-year returns for all sectors continues to be positive.

• On a 1-year basis, the Realty Sector continues to lead at 93.53% returns. Most of the housing companies have been showing overflowing order book positions and smart improvement in cash flows. RERA appears to have made the realty sector a lot more credible. At the same time, the frenetic growth of ecommerce and AI is creating demand for warehouses, competency centres, and data centres; which are driving the demand for commercial realty. Interestingly, realty sector is not just the top performer in terms of 1-year returns, but also in terms of 5-year returns. However, if were to look at 3-year returns, then the PSU banks have delivered the best returns to investors.
• Let us now turn to the other big gainers on one-year returns? Automobiles are an obvious second with 71.12% returns. For autos, it is not just the strong demand and the shift to EVs, but also the hope that the RBI would eventually move towards lower rates. The other big gainers were oil & gas at 64.12%, PSU Banks at 61.24%, and Pharma at 46.15%. Oil & gas sector has gained from lower crude prices in July 2024, which has pushed up the gross refining margins (GRMs) and the marketing margins.
• What about the bottom of the heap? We will ignore media as it is dominated by just one company. FMCG and private banks are under pressure; and this is largely driven by a number of genuine concerns. While HDFC Bank and Kotak Bank had an impact on the private banking space, there are also concerns on valuations, a slowdown in NII growth and narrowing of net interest margins (NIMs). For FMCG, the concerns are over monsoons, rural demand, and the likely impact of a spike in oil prices and food inflation.
• There are some dichotomies visible in the data. Private banks have been at the bottom due to concerns over its ability to sustain the robust growth in net interest income (NII) and the very high levels of net interest margins (NIMs). This has taken a toll on most of the banking and financial indices. FMCG, while looking smart in July, has struggled over the last one year due to concerns over rural demand. That demand has only been partially allayed in the last couple of months.

What stands about the return picture is that there is no sector giving negative returns over the last one year, with even the laggard sector like private banks delivering over 10%.

• HOW SECTORAL INDICES FARED ON RISK IN LAST 1 YEAR?

If returns are one side of the coin, the other is risk. Here we look at 4 parameters of risk. This is the ranking of sectors based on 1-year volatility as of July 31, 2024.

Sectoral Index	1-Year Volatility	1-Year Beta	1-Year Correlation	1-Year R2
Nifty PSU Bank	30.13	1.62	0.68	0.47
Nifty Media	29.06	1.03	0.45	0.20
Nifty Realty	26.36	1.31	0.63	0.40
Nifty Metal	24.68	1.48	0.76	0.58
Nifty Oil & Gas	23.54	1.42	0.77	0.59
Nifty Non-Banks	18.24	1.14	0.79	0.63
Nifty IT	18.18	0.72	0.51	0.26
Nifty Bank	16.57	1.13	0.86	0.75
Nifty Private Bank	16.38	1.09	0.85	0.72
Nifty Financial Services	16.04	1.12	0.89	0.79
Nifty Auto	16.02	0.89	0.70	0.49
Nifty Consumer Durables	14.63	0.73	0.64	0.40
Nifty Healthcare Index	14.19	0.52	0.47	0.22
Nifty Pharma	14.14	0.52	0.47	0.22
Nifty FMCG	12.41	0.44	0.46	0.21

Data Source: NSE Indices

The above table is ranked on 1-year volatility starting with the most volatile sectors and going down to the least volatile sectors. We have measured volatility by the standard deviation, which is the standard protocol to measure volatility.

• Although media figures near the top on risk, we will discount it from our analysis due to excess dependence on just one stock of Zee Entertainment. In terms of standard deviation of returns, the more aggressive plays during the year like PSU banks, realty, and metals are also high on the volatility scale. However, in these cases, it must be said that the higher volatility was compensated by higher returns; so, it was a worthwhile. On the low volatility side, you have the typical suspects like FMCG, Healthcare, Consumer Durables, and auto. Interestingly, Pharma and Autos have delivered solid returns in the last one year, even with low volatility, which would boost their risk-adjusted returns.
• What about Beta; a highly popular measure of systematic risk. Higher the Beta above 1, more aggressive the sector in terms of returns and risk. The high beta sectors in the year were PSU Banks, metals, oil & gas, and realty. Despite a high beta, private banks have not done too well. The low beta sectors were, obviously, Pharma, FMCG, and consumer durables; with Pharma delivering over 45% returns in the year, despite low levels of standard deviation and low beta. That is again a case of post risk-return trade-off.
• Finally, let us look at correlation and R². Correlation shows whether the sector offers diversification benefits versus a diversified Nifty portfolio. Lower the correlation, more the diversification benefit. From that perspective; Pharma, IT, and FMCG offer the best diversification benefits on a Nifty portfolio. The financial services sector continues to have a very high correlation with Nifty, which is not surprising. Adding pharma to the portfolio, not only offers high risk adjusted returns, but also diversification of risk. Probably, that is the medicine that the doctor has prescribed for your portfolio.

The surprise package this year was healthcare and pharma. It was low on risk, low on beta, high on diversification benefits and also beat the Nifty by 17 percentage points.

• SECTORAL INDICES AND THE VALUATION PLAY IN LAST 1 YEAR

Finally, we look at sectoral valuations on P/E, P/BV and dividend yield to identify the overpriced and underpriced sectors. The table ranks on P/E ratios as of July 31,2024.

Sectoral Index	Price/Earnings (P/E Ratio)	Price / Book (P/BV)	Dividend Yield
Nifty Consumer Durables	89.63	13.10	0.38
Nifty Realty	64.05	6.50	0.32
Nifty FMCG	49.04	12.07	1.64
Nifty Healthcare Index	44.37	6.36	0.47
Nifty Pharma	39.27	5.82	0.52
Nifty Metal	35.09	2.94	1.46
Nifty IT	33.38	8.49	1.90
Nifty Auto	25.83	5.84	0.75
Nifty Non-Banks	23.79	3.42	0.80
Nifty Financial Services	16.74	3.42	0.88
Nifty Private Bank	15.56	2.87	0.70
Nifty Bank	15.01	2.86	0.88
Nifty Oil & Gas	12.04	2.39	2.20
Nifty PSU Bank	9.12	1.44	2.00
Nifty Media	0.00	2.27	0.39

Data Source: NSE Indices

Here are some of the key takeaways from the three valuation parameters. Let us look at how the sectors stacked up on each of these valuation parameters.

• In terms of P/E ratio; consumer durables is the most expensive with a P/E of 89.63X. Among other sectors; healthcare, FMCG and realty also have P/E ratios in the range of 40X to 60X. To an extent, FMCG and consumer durables justify higher P/E ratios on brand value and moat; while healthcare has the IP advantage compared to the other sectors. In the case of realty; and to some extent metals, the problem is different. Here, the that the earnings growth has not kept pace with the stock price rally. That could create a problem for stocks in these sectors if valuations get stretched. On the downside PSU banks are still available at single digit P/E ratio, while oil & gas is at just about 12X. One big trend visible in the last one year is that IT has become a lot more expensive in P/E terms while private banks are not priced a lot more reasonably.
• How do sectors stack up on price to book ratio or the P/BV ratio? The P/BV does a good job for financial services companies, where the book value to price ratio is a key parameter. IT also helps in businesses with long gestation. However, the results are almost in sync with the P/E rankings.
• Finally, Dividend yield is the rupee dividend paid out by the company as a ratio of its market cap. At a sectoral level, companies with high dividend yield are considered relatively undervalued. The Nifty has a dividend yield of 1.19% as of July 31, 2024. In terms of sectors, some of the better picks are oil & gas at 2.20%, PSU Banks at 2.00%, and IT at 1.90%. Dividends have grown sharply in the last couple of years, but have been slowing with reference to the price increase, putting pressure on dividend yields.

The big question is; if these themes that have done well, how will they fare in the future. Investing themes go through cycles. For example, private banks were the stars about 3-4 years back, but they lag today. Realty and PSU banks have emerged as key themes in last year and half. Defence is the best theme in the last 1 year and 5 years. The moral of the story is to keep your strategy in tune with the momentum compass!