As the stock market eyes the first Federal Reserve rate cut today, its impact on the domestic IT services sector that caters to clients globally would be keenly watched. Historically, the start of Fed rate cut cycle has coincided with slowdown in IT services exports, as prior rate-cut cycles were preceded by a strong demand upcycle but the US economy went into recessions, as the rates peaked. Will this time be different?
JM Financial believes the current cycle differ on both accounts, as Indian IT players are likely coming out of spend normalisation phase. The probability of a recession is also relatively lower this time, it said.
While recent unemployment print does raise fear, impact on already optimised IT services spend might be limited and incrementally, things should therefore improve, albeit gradually, the domestic brokerage said.
"The last, more technical, impact of rate cut is lower cost of equity (equals higher PER). We plotted Nifty IT earnings yield with US 10-year bond yield since 2007. For the first time, US 10-year bond yields have risen (and sustained) above Nifty IT’s earnings yield. This reflects anticipation of bond yield going down as rate-cut resumes. In other words, any multiple expansion due to rate cuts might already be in the price," JM Financial said.
Ceteris paribus, JM Financial believes rate-cut led lower interest burden should benefit CME and manufacturing verticals more. Tech Mahindra Ltd (TechM), given 53 per cent exposure to these two sectors, is better placed. A revival of US banks’ spend, however, is a bigger impetus that benefits Infosys Ltd, Tata Consultancy Services Ltd and Wipro Ltd more, JM Financial said.
Net-net, JM Financial said Fed rate cut cycles lead to a lower cost of equity and drive stock multiples. They boost discretionary demand as economy recovers. Lastly, lower interest burden on corporates open up room for higher opex.
"The first one - higher multiples - has already played out to an extent. The second one is contingent on the economy’s landing variety (soft/hard) and hence still fuzzy at this stage, in our view. The last factor - lower interest burden - is the most tangible impact of lower rates," the brokerage said.
JM Financial said trajectory of interest cost increase for corporates across sectors has been far gradual than that of fed-rate and most sectors or sub-sectors have de-leveraged, albeit marginally, over the past four years.
"These trends suggest, quite logically, that corporates optimised debt and operations to cushion the higher interest cost. This is most prominent in Manufacturing and CME (Communication, Media and Entertainment) sectors. A reversal (of opex cuts) should benefit TechM more," JM Financial said.
Expectations of rate cut improving corporates’ ability to spend instantaneously might be a bit premature but JM's optimism, instead, is based on a likely attenuating spend optimisation cycle.
Infosys Ltd , Tech Mahindra Ltd and Wipro Ltd are among JM Financial's preferred largecap picks. In the midcap space, it likes Persistent Systems Ltd and KPIT Technologies Ltd.