Cloud over growth prospect sends tech stocks for worst annual rout since 2008 crisis

The possibility of a recession in the US next year, the largest market for Indian IT service providers, has led analysts to trim their earnings growth expectations.

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After doubling its value over the past two years, the Indian information technology index is on course for the deepest rout it has seen since the Global Financial Crisis of 2008 and analysts said it may get worse.

The Nifty IT index has fallen almost 30 percent so far in 2022, which is already the most since the 55 percent drawdown in the index in 2008.

The rout in Indian IT stocks comes amid a global reckoning for technology stocks with cash flows far into the future as higher interest rates forced investors to be more demanding on the multiples they pay for owning such stocks. A misplaced notion that Indian IT stocks fall under the same “tech” basket, although the earnings profiles are vastly different, is compounding the negative sentiment for these stocks arising from the real concern that near-term earnings could moderate because of the impending US recession.

Further, the spectre of a recession in the US next year, the largest market for Indian IT service providers, has forced analysts to dramatically trim down their earnings growth expectations for the sector.

“Accelerated normalisation of monetary policy in the US raises probabilities of a hard landing there and consequently low probability of positive surprises on the fundamental side (for IT companies) over the next 12-24 months,” Nirmal Bang Equities had said in April as it turned ‘underweight’ on the sector.

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If the probability of a US recession was minimal in April 2022, it now seems high as the US Federal Reserve presses on with aggressive interest rate hikes to slow down growth in the world’s largest economy.

Further, Europe is teetering on the brink of a recession following Russia’s invasion of Ukraine and the subsequent surge in energy prices that has stoked record inflation and forced monetary authorities to tighten policy rates.

“Consensus EPS downgrade cycle set in motion by economic concerns in the West has more legs, in our view,” Elara Securities said earlier this week in a note.

Companies bullish

However, Indian IT companies have not yet shown signs of trepidation over revenue growth. Infosys raised its annual sales growth guidance to 13-15 percent following its June quarter earnings.

MindTree’s chief executive officer Debashis Chatterjee told analysts at Motilal Oswal Financial Services recently that with technology becoming critical to revenue growth, spending on IT services isn’t feeling the pinch of macroeconomic weakness.

Brokerages such as Elara Securities said the hope of investors that IT service companies may surprise positively on margins and earnings per share (EPS) could be unfounded in reality.

Goldman Sachs downgraded its outlook on the sector earlier this month, citing further pain for IT stocks because of rising odds of a recession in the US.

Contrarian calls

Others on the Street are turning positive on the sector because of a sharp decline in valuation multiples this year and persistence of optimism from management executives on winning deals.

“We remain positive on the sector and prefer large caps over mid-caps,” brokerage house Bernstein India said in a note last week.

Axis Securities and IIFL Securities are banking on resilient long-term demand trends in the sector to result in possible re-rating in the sector once the current bout of volatility subsides.

“We believe the focus shifting to outsourcing should benefit India IT more, and growth in the medium term should remain higher than pre-Covid levels. We prefer stocks with better growth visibility,” IIFL Securities said.

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