What has led to the meltdown in technology stocks?

At the beginning of March, Infosys and TCS had a combined market cap of nearly $130 billion. In the first fortnight of March, these two companies jointly lost nearly $31 billion in market value. What exactly triggered this crash in the IT stocks?

Mar 19, 2020 12:03 IST India Infoline News Service

If you thought IT stocks were islands of peace amidst an ocean of turmoil, you need to think again. In the first 75 days of 2020, TCS and Infosys have given up nearly 1/4th of their value. This is a tad ironic because your normally expect the IT stocks to at least hold value when the rupee is weak. In fact, most of the fall actually came in the month of March 2020. 
Data Source: NSE

Most of the IT companies have been largely dependent on corporate IT spending demand from the US, UK and EU. Here is what has happened. Both the US and UK are announcing major shutdowns to avoid the virus from spreading. This is leading to huge loss of business. Consider the erosion. At the beginning of March, Infosys and TCS had a combined market cap of nearly $130 billion. In the first fortnight of March, these two companies jointly lost nearly $31 billion in market value. What exactly triggered this crash in the IT stocks?

Of course, it was the Coronavirus
In the last few weeks, any problem almost traces its origins to the Coronavirus. That is also correct in a way. There have been large scale shutdowns across major markets like the US, UK and the EU. China is just coming back from a shutdown but the damage is likely to impact growth till June. Most likely, China is expected to contract GDP in the Jan-Mar quarter and that could mean more trouble for GDP growth globally. After all, China is the biggest absolute contributor to increase in GDP each year. The IMF and the World Bank have already warned of an impact of 40-45 basis points on global growth. Normally, when growth comes down and fund flows are tight, the sticky expenses continue by default. However, IT spending is a lot more discretionary and could be the first to be impacted. That is hitting IT stocks.

Falling Crude prices are taking a toll on the IT industry
You may naturally wonder how the crude prices could really impact the fortunes of IT industry. Nearly, 40-45% of the overall IT spending globally comes from the oil and gas sectors and the tourism sector. Both these sectors have been badly hit. Oil and Gas companies are holding back their capital investments in the light of crude dipping to $30/bbl. This has put most IT spending by oil companies on hold. Secondly, the one sector that took the biggest hit in the aftermath of the Coronavirus is the tourism and travel sector. With most tours being banned, airlines running skeletal services and tourist spots shut, their troubles are only getting exacerbated. Here again IT spending is likely to take a hit.

New H1-B Visa System to hit Indian IT companies hard
The new H1-B visa system is likely to hit Indian companies in multiple ways. It will kick in from April 2020 onwards. Firstly, the cost of the H1-B visa is likely to increase from April. In addition, the processing time for the visa will also be extended from around 2 months to 4 months. Lastly, the visa process will go through registration and random selection and the visa process will only be applied on the shortlisted candidates. In short, the challenge for the IT companies is that it would be increasingly difficult for them to give timeline commitments to their clients. Costs are likely to go up and clients are likely to bargain for lower billing prices due to the slowdown. The impact will be felt on margins.

US rate cuts will only add to the risk in IT stocks
The US Fed has cut rates rapidly. In the first week of March, the Fed cut rates from 1.75% to 1.25%. Then in a surprising twist, the Fed cut the rates all the way to the lowest possible range of 0.00-0.25%. This was the rate that was first tried out in 2008 in the aftermath of the financial crisis. However, the sharp cut in rates is expected to weaken the dollar index. A weak dollar is never good news for IT companies because it would mean lower revenues on translation. That will only add to the pressure on the margins of IT stocks.

Finally, has the P/E of IT stocks become attractive?
Many of these problems are structural and hence may take time to resolve. The sharp fall in P/E shown in the chart below reflects that.
Chart Source: Equity master
One explanation for the sharp fall in P/E could be that the growth for the IT industry in this year is expected to fall from 5-6% on an average to negative growth. We will have to wait for the March quarter results and guidance for a clearer picture.

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