At a time of severe volatility, the generation of outperformers in markets has become even more challenging. Given this backdrop, domestic brokerage house Motilal Oswal has looked at the roles of two major and critical domestic sectors, which have crested multiple outperformers over the last decade – Banks and Information Technology (IT).
Banks and IT sector outperformed alternately in the last 10 years; will this trend continue?
These sectors together constitute 41 percent of Nifty50 and ~31 percent of NSE500 weights. The brokerage has analysed and highlighted how the relative divergence between these two sectors has played an important role in determining the relative out/underperformance of Indian markets.
On annual basis, Nifty50 declined just once in the decade, whereas Nifty Bank and Nifty IT each declined on three occasions during CY12-22.
The divergence between IT and banks over CY12-22
Over the past decade (CY12-22), the brokerage observed that while both Nifty Bank and Nifty IT outperformed Nifty 50, their performances remained highly volatile and divergent.
It further revealed that these two indices outperformed alternately over CY12-22. More importantly, the quantum of the relative performance gap between the two sectors was over 40 percent in 6 out of the 11 years and over 10 percent in 10 out of 11 years. The divergence ranged between 10 percent and 60 percent per year, highlighting the obvious but decisive role of getting the sector call right at the beginning of a CY, it noted.
According to MOSL, the average divergence between both indices stood at 37 percent over CY12-22.
"The gap has expanded sharply in years/episodes of macro disruption, which has become quite frequent of late (demonetization, GST, US-China trade war, Covid19, Russia-Ukraine war, Global Central Bank rate hike cycle, accidents in global banking, etc.). In fact, in the preceding three years, i.e. CY20, CY21, and CY22, the relative returns gap between Bank & IT stood at a staggering 58 percent, 46 percent and 47 percent, respectively, with IT outperforming in CY20 and CY21 while Bank outperforming in CY22. IT space has so far in 2023 outperformed Bank by 6 percent," it showcased.
The brokerage explained that both sectors have very natural and pertinent macro linkages - Banking being a microcosm of the broader economy cannot remain immune to the prevailing macro environment, both global as well as local while Technology meanwhile derives more than two-thirds of revenue from the US and Europe and has direct linkages with the trends prevailing in the global economy.
For example, since the start of Covid-19, the IT sector has – both in 2020 and 2021 – benefitted from the tailwinds of rising technology spending globally as digitization assumed mission-critical importance in an era of physical and social distancing. Meanwhile, the banking sector bore the brunt of weaker economic growth and concerns around deterioration in asset quality led by persistent lockdowns both in 2020 and 2021, it pointed out.
Analyzing the yearly performances of key sectoral indices over the last 10 years, the brokerage pointed out that benchmark Nifty50 with other key indices posted healthy double-digit growth during 2012-22.
While Nifty50 has reported a 12 percent CAGR in this period, Nifty Bank and Nifty IT clocked 13 percent and 17 percent CAGR, respectively.
During CY12-22, though earnings grew at a decent pace, both the indices registered even faster growth leading to rerating, the report stated, adding that earnings for IT grew faster in the first half of the decade, while Banks saw faster growth in the second half of 2012-2022.
In the first half of 2012-22, Nifty IT grew at a CAGR of 15 percent versus a 7 percent CAGR of Nifty Bank. Meanwhile, in the latter half, Nifty Bank grew at a 13 percent CAGR versus a 10 percent CAGR for Nifty IT, revealed MOSL.
P/E ratio: Nifty Bank’s 12-month forward P/E is near its LPA, whereas that of Nifty IT is trading at a 13 percent premium to its LPA, noted MOSL.
P/B ratio: Nifty Bank’s 12-month forward P/B is at a 7 percent discount to its LPA, while that of Nifty IT is trading at a 23 percent premium to its LPA, it stated.
According to the brokerage, during CY12-22, the total market cap of Nifty Bank reported a 15.9 percent CAGR to ₹31 lakh crore; whereas, the market cap of Nifty IT grew at 16.1 percent CAGR to ₹27 lakh crore. In comparison, the market cap of Nifty grew at a 14.1 percent CAGR in this period to ₹138 lakh crore.
While the market caps for Nifty Bank and Nifty IT grew at a similar pace over the last five years, the pace of growth for Nifty IT was higher than Nifty Bank in the previous five years, it further observed.
Further, the market cap contributions of Nifty Bank and Nifty IT narrowed to a similar range of 20 percent to that of Nifty-50 in CY23YTD. Besides, the trends of contribution were similar with respect to Nifty-500 as well. The market cap contributions of Nifty Bank and Nifty IT constituents in Nifty-500 were higher by 40 bps and 60 bps to 12 percent and 10.3 percent, respectively, in this period, it said.
Mutual Fund allocation
The brokerage also informed that the MF allocation in banks remained strong with an average of 22 percent in the last five years, down 330 bps from the 2019 peak. Whereas MF allocation in IT companies remained volatile with an average of 10 percent, up 440bp from 2017 lows, it added.
Overall the MF allocation in banks has been almost twice that of IT stocks, highlighted MOSL. It further noted that in 2019, MF allocation was the highest in banks, while it was near the lowest level in IT, while in 2021, allocation in banks was the weakest, but was the highest in IT.
Banks’ weight in Nifty50 peaked in 2019, whereas IT’s weight peaked in 2021, in line MF allocation trend, it added.
Overall during 2012-22, the weightage of Banks in Nifty-50 grew 820 bps to 38 percent whereas, that of IT stocks rose 260 bps to 14 percent.
Can this divergence continue?
Given the prevailing macro backdrop, MOSL expects the divergence in the performance of these two sectors to continue as both global and domestic economies are going through a challenging phase with moderate growth, rising rates and persistent inflation blurring the near-term outlook.
It noted that while Bank’s earnings growth over the last 3/5 years has been solid, the sector has seen a de-rating recently impacted adversely by several stock-specific factors as well as macro concerns around sustenance of current elevated margins, pick-up in deposit growth and persistent FII outflows from India.
On the other hand, it pointed out that after a very strong 2020 and 2021, the IT sector was the worst performer in the family of Nifty sectoral indices in 2022 with a 26 percent decline as concerns around potential US recession, a sharp rise in the US interest rates and elevated challenges in the US BFSI industry (a key contributor to the Big-5 Indian IT firms) have put a cap on the IT sector’s re-rating potential.
In 2023 till date, Nifty Bank is down 8 percent whereas Nifty IT is down 2 percent. In comparison, the benchmark Nifty50 is down over 6 percent in this period.
Going ahead, the brokerage said that the valuations of both these sectors are quite reasonable. That said the relative divergence between the two can continue and will be a function of 1) how the global macro shapes up amidst the current flux and 2) the relative earnings progression for these sectors.
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