IT in­vestors con­tinue to ig­nore weak US eco­nomic data

The Pak Banker - - 6BUSINESS -

NEW YORK: The de­cel­er­a­tion in de­mand for in­for­ma­tion tech­nol­ogy (IT) ser­vices could con­tinue for months, key lead­ing in­di­ca­tors from the US sug­gest. An­a­lysts at No­mura Fi­nan­cial Ad­vi­sory and Se­cu­ri­ties (In­dia) Pvt. Ltd point out in a 2 March note to clients: "US man­u­fac­tur­ing PMI (Pur­chas­ing Man­agers In­dex) re­mains in con­trac­tion zone at 49.5 (com­pared with a near-term peak of 58), which im­plies that near-term IT stock per­for­mance and IT de­mand in the US could be im­pacted, as PMI is a lead­ing in­di­ca­tor for both."

De­spite a sharp fall in PMI since end 2014, the Nifty IT in­dex has out­per­formed the broader mar­kets by about 7% dur­ing the same pe­riod. The drop in PMI is usu­ally re­flected in IT ser­vices de­mand with a lag of about two-three quar­ters. Ac­cord­ing to No­mura's cal­cu­la­tions, tier-1 IT ser­vices firms grew rev­enue by more than 13% in con­stant cur­rency terms in the De­cem­ber 2014 quar­ter. Growth re­mained in the 13% range in the next two quar­ters. And, sure enough, growth rates started fall­ing af­ter a three­quar­ter lag (since the time PMI started to fall), and stood at 10.6% in the De­cem­ber 2015 quar­ter.

With PMI mov­ing into the con­trac­tion zone (below 50) since Oc­to­ber 2015, growth rates can be ex­pected to fall fur­ther this year. No­mura's an­a­lysts add that "the fi­nan­cial per­for­mance of key client in­dus­tries (bank­ing and fi­nan­cial ser­vices, in­sur­ance, retail, con­sumer, chem­i­cals and hi-tech) has wors­ened over the past three to four quar­ters, with pharma and auto be­ing the only sav­ing grace". Be­sides, pri­vate sec­tor job ad­di­tions in Jan­uary this year were the weak­est in the last five years.

If you thought that the de­pre­ci­at­ing ru­pee would pro­vide some buf­fer for prof­its at a time of de­clin­ing rev­enue growth, note that op­er­at­ing profit mar­gins are near five-year lows.

All told, the IT ser­vices in­dus­try is far from be­ing strongly placed enough to jus­tify out­per­for­mance vis-a-vis the mar­kets. Hav­ing said that, as is the case so of­ten, there is a scarcity of de­cent al­ter­na­tives, thanks?to which the?IT stocks con­tinue to trade at healthy val­u­a­tions.

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