Technology sector isn't a compelling buy

There is a strong and obvious correlation between the CNXIT and the Nifty. Several high-weighted IT shares such as TCS, Wipro, Infosys and HCLTech are included in the Nifty. So, the two indices move in the same direction.

But, the CNXIT is more sensitive to the rupee’s moves versus the dollar. It is also sensitive to the fluctuations of the Nasdaq and Dow Jones Industrial Average (DJIA). The short-term sensitivity of the rupee-dollar rate is influenced to a significant degree by FII attitude. FII net sales are often reflected by weakness in the rupee — probably because of dollar-denominated redemptions.

 

The CNXIT is inversely correlated to the rupee’s strength — it often rises when the rupee weakens. So, it forms some hedge to FII sales. This might have helped it outperform through the downturn between January 2008 and June 2009, when the FIIs were heavy net sellers.

The CNXIT and the Nifty actually bottomed with fairly similar retracements of nearly 60 per cent off their respective peaks. But, the CNXIT is up around 28 per cent over its January 2008 levels, while the Nifty is well below its January 2008 all-time highs.

The returns since January 2010 have been almost exactly the same for both indices, at 4.9 per cent. It may be noted that the FIIs have been net buyers since January 2010 and the rupee is marginally weaker than it was in January.

Fundamentally, IT advisories over the next year or so aren’t very strong. The US economy is weak and Europe is even weaker making life difficult for the IT industry. Extraordinary volume growth or stronger margins are difficult to envisage in these key markets.

Nevertheless, the industry has unquestionably been favoured in comparative terms when it comes to share pricing. Is this comparative outperformance likely to continue? It is possible to make logical arguments either for or against.

In terms of valuations, the CNXIT is at a trailing PE of 24.5 (for the past four quarters), somewhat higher than the Nifty’s 23.5. This is an average of course; individual companies could do a lot better or worse. The advisories and the first quarter performances make it unlikely that this PE could be justified for the entire IT sector over 2010-11, though the best performers might make it look acceptable.

A purely fundamental investor, focussed on value would be uncomfortable about the sector. A technician would be either neutral or positive. Somebody who is invested should probably stay invested. While the sector isn’t compellingly strong, there is no other sector that is looking markedly better.

The author is a technical and equity analyst