The Bombay Stock Exchange’s IT (information technology) index is the only sectoral index to have fallen by less than 10% from its closing high in January. One of the reasons for the lower decline is the fact that IT stocks had already underperformed by a large margin in 2007.
But another factor was the bout of buying since late last week, on the premise that IT stocks were available very cheap. Prior to the relief rally, trailing valuations on frontline stocks were around 18 times trailing earnings. Now, valuations have reverted to about 20 times.
Remember, core operating profit has grown by just 18% for Tata Consulting Services Ltd (TCS) and Infosys Technologies Ltd in the first nine months of this fiscal, so that doesn’t leave much on the table. (For Wipro Ltd and Satyam Computer Services Ltd, it was even lower at 8% and 15%, respectively.) So far, the sound bytes from software and software services providers have been cautiously optimistic. While technology companies such as Intel Corp., which cater directly to end-consumers, have been hit by the economy slowdown in the US, software providers such as SAP AG and Oracle Corp. have sounded optimistic while releasing their December-quarter results.
But the full impact of the US slowdown has not yet been seen. Volume growth slowed down for most Indian IT firms last quarter. Some analysts fear that given the bad shape that large US financial services companies are in, they wouldn’t shy from cutting prices. Volume growth may still be easy to come by, given the large size of the addressable market, but IT companies’ biggest customers currently are from the financial services sector, who are likely to look at price cuts to save on costs.
Meanwhile, news of layoffs by TCS and IBM Corp. is being viewed with some caution, especially given its timing and the fact that India’s three biggest IT players have cumulatively maintained net employee addition at last fiscal’s levels so far.
The next major event that would determine the future of IT stocks is the 2008 outlook of Cognizant Technology Solutions Corp., which will be released later this week. Cognizant gets 46% of its revenues from the financial services segment, and its guidance will bring some clarity as to how badly this segment is hit.
A bear market rally?
Even Marc Faber, one of the biggest bears in the market, believes that a bounce in the market is overdue. In his market commentary published on 30 January, Faber says the US market had become extremely oversold. He believes that “For the S&P 500, a relief rally toward 1,450 is possible and would afford an excellent opportunity to reduce positions.” At the time of writing, the S&P 500 was at 1,380, well below that level.
Faber is clear, however, that we’re in a long-term bear market, which is why he sees rallies as exit opportunities. His thesis is that while past market declines since the early 1990s in the US have been cushioned by real estate prices, this time that support is lacking. Faber believes the combination of falling equity values and a housing bust will impact US consumption in the months ahead.
What of emerging markets? The bear guru’s dire forecast for emerging markets is based on three arguments. One, he says the US current account deficit, the principal source of liquidity for emerging markets, is declining. Two, he points out that there is a positive correlation between emerging market stocks, commodity prices and the Baltic Dry index—they tend to move up and down in concert. And finally, he writes that “while I am not positive about US equities,?I?believe?that US stocks could outperform foreign markets for a few months as foreign markets are likely to decline more than the US market. This process seems to have begun now”.
There are other reasons why a sharp bounce could occur. Investors in the US have fled the stock markets to the safety of government bonds, driving down the yield on the 10-year treasury note to 3.6%, well below the consumer price inflation rate of 4.1%, while the yield on two-year treasuries have been bid down to 2.5%. That, say analysts, is an indication of fear in the markets. EPFR Global, a research outfit that tracks global fund flows, points out that money has been flowing out of equities into US money market and bond funds—these funds absorbed a net $12.9 billion in the week to January-end, while outflows from developed market equity funds and emerging market funds totalled $13.6 billion and $2.9 billion, respectively. If the rally continues, some of that money could rush back into equities, sending markets sharply higher.
Even if we are in a long-term bear market, sudden rallies will continue. Faber says the 2000–02 bear market was interrupted by two rallies of more than 10% and three rallies of more than 20%.
During the last bear market in the Indian markets too, we saw several intermediate rallies. For instance, after falling 38% between February and May 2000, the Sensex rallied 32% between May and July 2000.
Similarly, between October and December 2000, the Sensex saw another rally, sending it up 24%. Yet another rally was between October and December 2002, when the Sensex rose 21%.
This year, after plunging 28% from its highs, the Sensex has rallied 22% off its lows. The difference this time, point out the bulls, is the sharpness of the move, which is unlike a bear market, where the markets grind down slowly.
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