The performance of IT stocks show that they have fallen out of favour. So far in 2022, the Nifty IT has fallen 27 percent while the sectoral gauge is down 22 percent in six months.
IT stocks had taken a severe beating, factoring in the aggressive tone of United States Federal Reserve chairman Jerome Powell at the Jackson Hole Symposium in Wyoming. After a rebound, they resumed their fall on September 14, reacting to the hotter-than-expected inflation data released in the US, which many said signals a more hawkish Fed. With that, the Nifty IT index tumbled 4 percent.
Surprisingly, JPMorgan has also recently downgraded its rating on all technology stocks in its portfolio citing continued margin pressure. Here’s what has been causing rout in IT stocks:
What was Powell’s speech about at Jackson Hole?
Powell said the US central bank would continue raising interest rates in a way that will cause “some pain” to the US economy.
Despite four consecutive hikes in interest rates totalling to 2.25 percentage points, Powell believes this is “no place to stop or pause” even if benchmark rates are near an area that is considered neither stimulative nor restrictive to growth.
The Fed chair explained that higher interest rates will bring down inflation but they will also cause some pain to households and businesses. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain,” he said.
What was the inflation reading in the US and what does it imply?
The US Labor Department’s Consumer Price Index (CPI) report on September 13 showed that August CPI increased at an annual pace of 8.3 percent, more than economists’ median estimate of 8.1 percent.
This hotter-than-expected reading led to a perception that there will be an even more aggressive monetary tightening by the Federal Reserve next week in its policy meeting, cementing bets of a large 75-basis-point interest rate hike.
How does Powell’s speech and higher inflation affect Indian IT companies?
Outlook for the US and Europe is important for Indian IT companies as the bulk of their revenues come from these markets.
The US and Europe together contributed around 86 percent to Indian IT firms’ revenues in FY22, ratings agency CRISIL recently highlighted.
Powell’s remarks and the higher-than-anticipated inflation print have stoked recession fears, which would mean a cutting back on IT spending by American and European corporates, which in turn would hit earnings growth of Indian IT companies.
According to analysts, North America contributes 61 percent to Infosys’ revenue and Europe 25 percent. North America and Latin America form 55 percent of revenues for Tata Consultancy Services (TCS) while the UK and continental Europe constitute 30 percent. For Wipro, 60 percent of sales comes from the US and 28 percent from Europe.
How have IT stocks performed lately?
Shares of Infosys, TCS, Tech Mahindra and Wipro have slumped 16-42 percent in 2022 so far.
What is the outlook for the sector?
With the Indian IT sector already trading at 28 times its one-year forward P/E compared to its past 10-year P/E of 18 times, ICICI Securities believes much of the growth and earnings expectations over the next three years are factored into the share prices. Hence, the brokerage firm is cautiously optimistic after a three-year-long bullish stance on the sector.
JPMorgan on its part believes margins of IT companies will continue to take a hit in the medium term. It has turned more bearish on the sector.
CRISIL said resumption of travel and rising cost of hiring at a time of high attrition will moderate operating margins to the pre-pandemic level of about 23 percent this fiscal. Significant cost savings had driven margins to a peak of 26 percent in fiscal 2021, which then moderated to around 24 percent last fiscal.
Nomura has retained its cautious view on the sector. It sees more evidence of revenue slowdown ahead in the sector and added that slowing revenue and high inflation will likely dampen IT budgets.
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