All odds in IT's favour

Through the 2008-09 bear market, the best performing industry was information technology (IT). Although growth rates shrank, the falling rupee provided a cushion. As a result, the CNXIT index consistently outperformed the broader market and in fact, IT was the only sector to see capital gains.

Things changed during the bull market of 2009 and 2010. Other industries outperformed IT. What is more, as the rupee strengthened, the IT industry’s growth rates became more anaemic. In the past year or so, the IT industry has registered lower growth rates and the advisories have been very cautious.

The US is in recession, or weak economic recovery, and there is little new spending in IT or otherwise. Europe has been on the edge of potential chaos and again, spending in that zone has been slow. There was a brief burst of investment into IT shares, when the rupee dropped to new lows in late 2011. But, the recent recovery has taken the sheen off again.

Nevertheless, it remains a good counter-cyclical bet. It has a fair degree of predictability and reliability despite being cyclical. By and large, IT industry advisories can be trusted because the track record of projections being met is good.

The earnings projections broadly suggest that valuations across the IT space are not far from fair value. This is in contrast to other industries, where valuations are well above fair value or projections are highly optimistic or often, both.

There could be a few drivers for IT stocks in the next two quarters. One is that the industry will meet its projections whereas other sectors probably won’t. Second, any broader market sell-off will probably push the rupee down again and IT promptly starts looking better in those circumstances.

The third is, in a scenario where corporate debt is a drag on bottomlines, the debt-free nature of the IT industry is a shining contrast. Foreign corporate debt is likely to be in focus in the next 6-9 months. Quite a few companies will be faced with the need to redeem hybrid instruments like FCCB with cash - their current share prices are trading way below agreed conversion prices. That redemption pressure will hurt the rupee.

If the market reverts to a phase of extended bearishness, the virtues of the IT industry will be highlighted again. So, should traders or investors be going overweight in the industry? This depends on how optimistic you are. If you think the bull-run will continue, IT will be low on the priority list. Otherwise, it could continue to be a good hedge.

The author is a technical and equity analyst