Let’s talk about the tech selloff overnight. Facebook lost 26%, its biggest ever selloff. Mark Zuckerberg is not in the top 10 list of the richest people on planet earth anymore. Are these stocks falling under their own weight? Do you think these tech giants are going to have to restrategise as to how to build in those growth numbers going forward? Eventually it is the one with the deepest pockets which is going to win the race perhaps?
You have answered the question. There is the next leg of technology transition; short videos are taking a lot more share in terms of viewer time and therefore the engagement levels and ad rates that you can get and revenues are starting to fall. There are some companies which are now starting to lose subscribers or rather monthly active users on their apps. This is a technology transition which has been imminent. The very reason that they have been restrategising is perhaps because they could see it coming and the market has now woken up to them.
But at the same time, there are other tech companies which are still holding on and they have reported very strong numbers. I must say that this transition is something that the market has woken up to and this is perhaps compounded by the uncertainty around interest rates. When we have zero percent interest rates, it does not matter whether you have money today or tomorrow or five years later, but if the interest rates and real interest rates start to move up, then question comes as to whether there is uncertainty in the outlook for the next five or ten years and then the market starts to panic.
We are seeing some of that in the Indian space as well. So as US bond yields have gone up, some of the new tech listings have seen a very sharp selloff. They have to prove that they can actually generate profits and that is what the market will trade off. It is a blend of both of these things. Yahoo used to be a very big success and then because it could not keep pace with the pace of change of technology, it slided down. It is a fast changing world. The second issue is that interest rates which have changed.
Meta and Instagram are not the same as TCS and an Alphabet is surely different from Infosys. Are we looking at a long drawn patch of time-wise consolidation/correction in the Indian IT sector as well? Or is this a knee-jerk reaction playing out and is going to erhaps restrict itself to the new-age tech companies, the newly listed universe?
The second argument we gave for the selloff is something that applies to the Indian IT space. , so if you measure the Z score or rather how many standard deviations above they are in terms of their average PE, the IT space was the most expensive and which is why we were underweight in the sector. I do not think it is about the selloff in Nasdaq which is affecting the Indian IT stocks. There may be some minor links, but this is just related to the fact that this sector had seen a lot of momentum which had pushed it up to price to earnings levels which were perhaps unsustainable and now it is seeing a correction.
We wrote last year about how the need to write software and the need for software engineers in India was going up very sharply but a lot of it was happening outside the Indian IT services companies. It was in SaaS companies which can generate $80,000 to $100,000 per person. Offshore IT engineers can generate $35,000-40,000 per person and therefore the ability that a global IT major or a software services company or a tech startup or even captive centres of large banks like ours can pay is, of course, substantially higher than what an IT services company can pay and so their margins and churn would get affected.
Some of that remains an overhang. The world will need more software over the next few years. There are very few places other than India where you can get those engineers and so that demand for engineers perhaps may outpace the demand for the IT services firms abd this has been a concern for us. But some of the selloff that we have seen is just a selloff of high price to earnings names.
We have been talking about PE compression and it is not just in the tech space. Now there are two schools of thought. We can have a situation where it looks expensive now but two or three years down the line, it may not look expensive. Is that a readjustment which is taking place or what is considered to be fair value? This is not just for IT, this could be for FMCG and it may be one day going forward, even for the value stocks.
Totally. So this is where interest rates and the discount rate start to matter. So if one is of the view that it does not make a difference whether the company is making profit today or three-four years down the line, so long as it can grow, the company is being evaluated on how fast it can grow and how much metal or better to the metal kind of investment they are doing so basically even they incur losses or they need persistent inflows of cash.
Those assumptions start to change when the assumptions on US rates start to get modified. So to take a step back, two years back was very difficult for everyone. I do not want to criticise policymakers but every country had to decide how much monetary and fiscal stimulus was to be given because clearly there was going to be a recession as lockdowns were being imposed and how much one should give.
In hindsight, we can go and see whether too much was delivered or too little. In the developed economies in particular, which did a lot of money printing, there has been a sharp surge in the cash being deposited back overnight with the central bank. In the US, it is $1.5-2 trillion. In Europe, it has gone up to $4 trillion. In Japan, some people says it has always been high and it has been about $4 trillion which means that too much money was printed.
On the fiscal side, if one tracks retail sales, in almost every major economy other than the US, the retail sales are at or slightly below trend. In the US, they had gone up to 10-11% above trend. These are 6-7 standard deviation events which should not have happened. That means too much stimulus was delivered. Therefore, regulators now with the benefit of hindsight are now realising that they need to wind it down and as that winding down happens, the markets are in a very different place than they were in the last 10-15 years, in the sense that at every whiff of weakness, the expectation was that the Fed or the US government or some large central bank would come and print money and will bail us out.
Right now, there is a situation where the demand numbers are starting to fall but the policymakers are busy fighting inflation because they are now busy unwinding what they did over the last two years. The markets are not really anchor to that. As this happens, uncertainty about the future goes up and that is bad for PE multiples.
As people are very certain about what is going to happen, consumer staples and some of the healthcare names trade at such high multiples because of reasonable visibility on what the earnings will be three, four years out. One cannot have that for metals or for oil and that is why those stocks trade at lower multiples. When there is greater uncertainty on what may happen over the next two-three years, it is natural to see high PE stocks starting to come off.