There has been a tangible shift in stock market preferences over the past few weeks. The action has shifted away from the socalled quality basket towards the high-beta names. High beta stocks from frontline indices have outperformed sharply for over two months—a trend reversal from earlier when only quality stocks were flying. Does this beta rally have enough legs to push on? How can investors make the most of it?
In market parlance, beta is a measure of a stock’s volatility relative to the overall market. High beta stocks are those in which prices fluctuate more than the market. A stock that swings more than the market over time has a beta above 1, while stocks that deviate lesser than the market have a beta less than 1. High beta stocks oscillate more as the businesses are typically cyclical in nature. These are either closely linked to the changing economic macros, government regulations or have political affiliations. Shares of companies in sectors like financial services, capital goods, construction, metals and certain consumer discretionary names belong to this segment. Some of these are assetheavy businesses with high debt.
The quality basket—characterised by high earnings visibility, growing profitability, strong cash flow, low debt and high return on capital employed—has been favoured by investors over the past few years amid the broader economic slowdown and muted corporate earnings growth. Most of these stocks have a low beta or volatility, and are perceived to be more stable. Interestingly, high beta stocks within Nifty50 have outperformed low beta stocks since September 2019, points out a ICICI Securities report. This uptick has been led by metals stocks like Jindal Steel & Power, Tata Steel and Steel Authority of India. Several stocks from the financials space have also contributed, like Motilal Oswal Financial Services, Indiabulls Housing and LIC Housing.
High beta stocks have soared in the past few months Global liquidity and expectations of a big-bang Budget have been fanning sentiments in these stocks.
Analysts say beta rallies tend to be driven by optimism about policy measures, improving growth outlook and low interest rates. Often, the fuel propelling a beta rally is ample liquidity. The current rally seems to be deriving much of its strength from global liquidity. “Globally, a risk-on sentiment has taken hold, driving investors towards riskier assets,” says Vikas Gupta, CEO & Chief Investment Strategist, OmniScience Capital. Among reasons are lowering interest rates by dovish central banks, de-escalation of US-China trade war and waning of recession fears in developed markets. Among domestic factors, the government’s mega infrastructure push has raised hopes of higher credit growth and private sector capex. Expectations of a big-bang Budget are also fanning sentiment in high beta stocks.
Some feel this shift has enough legs to run for a while. “This shift in market preferences towards beta marks the beginning of the pendulum swing from extreme risk aversion to rising risk appetite,” opines ICICI Securities. Tata Steel, Jubilant Foodworks, Tata Motors, SBI and Ultratech Cement are its preferred picks. According to Equirus Securities, while commodities have already seen a decent run, much more is on the cards. “Among cyclical stories, we are becoming constructive on the capital goods space, banks and utilities,” it says. Jyoti Roy, DVP, Equity Strategist, Angel Broking, says the broader markets will perform better in this scenario as valuations are in favour. On the contrary, expensive quality stocks have started underperforming, particularly where growth is not matching expectations. Shares of index heavyweights have come under pressure owing to earnings disappointments.
However, analysts caution against putting large bets on a beta-led rally. Despite the rally, risk aversion continues to be high in the domestic market. High beta has outperformed selectively and is not broad based. So far, only the large beta stocks have outperformed. Beta stocks from the mid- and small-cap basket are yet to catch on meaningfully. The tide may also sweep up some undeserving, low quality stocks.
Be particularly careful of high debt companies participating in the rally, warns Gupta. “Investors must distinguish between leveraged companies and low debt names taking part in this uptick,” he says. The latter have inherent fundamental strengths supporting the uptick, such as better cash flow, decent earnings traction etc. Betting on highly leveraged businesses is speculative play that could hurt. If things don’t pan out, the price will revert.
Further, beta-driven rallies can often be short-lived. In the past, several false triggers have been seen, finally amounting to nothing. Recent experience also provides ample evidence that a global shock could increase risk aversion, thereby halting the global risk-on rally. Any flare-up in US-Iran tensions or lack of incremental progress in US-China trade deal may play spoilsport in global risk-on trade. Domestically, rising consumer inflation remains a threat to the low interest rate regime. The rally could fizzle out if the upcoming Budget 2020 fails to meet heightened expectations. In this scenario, investors looking to play the beta rally should exercise discretion.
“Even as broader markets start participating, the focus within this pack will remain on quality businesses supported by earnings growth,” insists Roy.