Why sector rotation matters after a geopolitical slowdown

When geopolitical tensions escalate due to war, border skirmishes, or global unrest we see that markets rarely react in a uniform manner. Different sectors of the economy respond differently to macro shocks, and understanding these shifts can help investors protect their capital and improve long-term returns. In such times, sector rotation becomes more than just a tactical idea, it becomes a practical and profitable strategy.

Take the defense sector, for instance. Following the Pulwama attack in 2019 and the Indo-China border tensions in 2020, India ramped up its defense budget and prioritised local manufacturing under the Atmanirbhar Bharat mission. This move provided a long-term tailwind for companies in the defense space, which benefited from increased government contracts and strategic focus. The seed was sown much earlier when the NDA government was sworn in in 2014 and a comprehensive new Defense Policy was envisaged.

Meanwhile, when geopolitical uncertainty leads to slowing demand and a fall in inflation, consumer goods companies tend to benefit. Lower prices of key raw materials like palm oil, wheat, and packaging inputs lead to improved margins. At the same time, greater affordability lifts consumption of essential items. In 2023, with wholesale inflation turning negative, many FMCG firms saw their profits improve.

In contrast, auto and discretionary sectors often take a hit during such slowdowns. When household incomes are under stress due to job losses or rural weakness, and financing dries up, as seen during the NBFC crisis in 2019, vehicle sales and demand for non-essentials tend to shrink.

IT services behave differently. These firms usually benefit in the later stages of a slowdown, especially if the rupee weakens and global firms increase outsourcing. During COVID-19 and the digital acceleration that followed, Indian IT firms saw strong demand from the West. The rupee’s depreciation also helped improve margins, leading to solid earnings growth.

Commodities and metals typically see short-term spikes when conflicts disrupt supply chains. But these rallies can be fleeting. In 2022, for example, prices surged post the Russia-Ukraine war but corrected sharply as demand normalized and central banks raised interest rates to control inflation.

Banking and financials are closely tied to the interest rate cycle. During the initial phases of a slowdown, credit growth weakens and fears around loan defaults rise. But once central banks cut rates to revive growth, as they did post-COVID we saw banking stocks bounce back.

Then there’s infrastructure and capital goods. These sectors usually do well in the recovery phase, especially when the government steps in with public spending. From 2022 to 2024, Union Budgets with a clear focus on capital expenditure gave a strong boost to infrastructure-related industries, creating multi-year growth stories. 

The Indian market’s performance over the past five years highlights how sector rotation is not just theory, it works in real life. In 2020, pharma and IT led the charge. In 2021, it was the turn of commodities and infrastructure. By 2023, with inflation tapering and economic uncertainty lingering, consumer staples and utilities offered more stable returns.

To sum up, sector rotation helps investors adapt to evolving economic conditions. By adjusting exposure to align with inflation trends, interest rate moves, currency shifts, and government spending patterns, investors can make the most of post-slowdown recoveries. It's a disciplined way to stay a step ahead of the market, and a strategy that deserves more attention in every investor's playbook.

As the well-known American investor, Peter Lynch once said, “Know what you own, and know why you own it.” Sector rotation is simply the act of applying that wisdom to the bigger picture without having to speculate on specific stocks. 

To make sector rotation easier to implement, having a strategy that offers a clear, data-driven way to act on macro signals will be beneficial. One can build ETF baskets based on timely financial metrics like PAT growth, margin trends, and capacity utilization, all tailored to each sector. The process can be rules-based and updated quarterly using self-learning models. The process can then select sectors showing strong performance, filters out weak ones, and rebalances accordingly. This removes the guesswork for investors trying to time sector shifts. During downturns or post-conflict recoveries, we have found that such a process can help investors move into more resilient or high-growth sectors quickly and efficiently. For busy investors, it’s a structured way to ride macro cycles without active stock-picking.

(The author is Founder and CEO at Maxiom Wealth)