There's uncertainty in the equity markets and churn happening from cyclical to defensive sectors. Investor nerves are frayed! What better way to calm your nerves than to go take a deep look into the macros & the sectors to help you make more informed decisions as the business cycle progresses from this short term correction.

Understanding sector dynamics is key to understanding the business cycle. Once you have identified the strong and weak sectors, you can then compare the results to a theoretical business cycle chart and - hopefully - determine the part of the business cycle the market is in. That information, in turn, may help you predict which sectors will strengthen in the coming weeks and months.

So in this post we do a deep dive into the markets, factors & sectors!

Market Overview

While the smaller stocks have been having a spectacular run this year, last month was bad for the smallcaps and midcaps. The decline in smallcaps was in part attributed to the change in BSE surveillance rules relating to smaller stocks and in part was attributed to the correction due to tapering fears.

Factors Overview

Looking at the market factors, the high flying market factors, Momentum & Alpha took a breather this month while Value & Quality outperformed.

Sector Overview

Looking at the sectors, the biggest outperformer of the year, the metals sector also had a bad month. This is because of the strengthening of the US dollar. The IT sector came out a winner in the sector and monthly performance charts. Realty, Pharma and PSU Banks dipped while the defensive FMCG and Consumption sector were strong. The cyclical sectors saw correction while the defensives like IT & FMCG stayed strong.

The move of defensives above cyclicals suggests a consolidation and people are fearing a consolidation as the Federal reserve key policy meeting at Jackson Hole is about to be hosted at the end of August where a tapering could be announced.

Uncertainty around Tapering

There is no sure shot sign that the Fed will act one way or the other. A big chunk of the US markets are underperforming in terms of business activity and the coronavirus Delta variant is rising. The consumer confidence numbers are coming down. The Fed might stay dovish for a while longer.

But on the other hand, the employment numbers are improving, inflation is picking up. Jackson Hole will tell us hopefully how the Fed is thinking and will provide clarity to the markets.

Whatever might be the outcome of the Fed meeting the markets should continue to be favorable due to the strong economic environment. The handling of the tapering is also expected to be done in a much graceful way than last time causing less impact on markets.

A favorable market

We are seeing a churn taking place while the markets stay largely favorable. The rotation of defensives taking over cyclicals was unexpected and can only be described on the basis of the US tapering fears. Stocks which were underperforming or moving sideways, came into reckoning like technology and especially midcap tech. Some of the consumption stocks like alcohol, quick service restaurants have also come into focus. While the small and midcap stocks have corrected over the past two-three weeks or so, the market has been held up by large cap tech companies and to an extent some of the consumer related businesses.

This churn is perfectly fine in a bull market as long as we do not have a steep correction.

Performance Overview

It’s been a tough month for the equity portfolios. Smallcaps have fared the worst and Momentum & Quality have been the better performers this month. We are hoping for a recovery post the Fed policy announcement in our cyclical heavy portfolios, otherwise we should make a pivot towards more defensive stocks.