IT sector set for 2H25 comeback backed by low base, global tailwinds: Ambit Capital
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After a muted first half, India's IT sector may be gearing up for a meaningful revival in the latter half of 2025.In this edition of ETMarkets Smart Talk, Nitin Bhasin, Head of Institutional Equities at Ambit Capital , along with Bharat Arora, shares why the sector is entering a favourable zone—driven by seasonality, an uptick in global tech demand, and contrarian signals like low index weight and weak CEO confidence.The duo also offers a detailed playbook for navigating FY26's volatile and concentrated market, including preferred sectors, fixed income strategy, and the rising importance of quality and low-volatility stocks in a stock-picker's market. Edited Excerpts -A) We are in the phase of rise in stock market concentration, wherein market returns are muted, and large-caps outperform mid-caps and small-caps.This has been the case in CY25TD wherein large-caps (8%) have outperformed mid-caps (4%) and small-caps (relatively flat), and we expect this to worsen going forward.Time to be selective as FY26 is expected to be a stock-picker's market & we expect this trend to continue in FY27 as well.Over the next few months, we believe a key monitorable will be trailing market returns. Historically, moderation in returns has led to moderation in DMF equity flows, which have already halved since Dec-24.Even if markets remain at current levels, TTM returns of Nifty as well as top mid-cap & small-cap schemes are likely to remain muted/negative as base hardens, which can further exacerbate correction.A) Defensive sectors such as FMCG , Pharma and IT are the biggest OWs in our model portfolio, due outperformance in periods of rising market concentration.Historically, FMCG & Pharma have exhibited lower volatility in returns as compared to other sectors.In 1HCY25, market breadth remained narrow with median stock (-0.5%) lagging the NSE500 index (5.5%) by ~6%. We expect this to continue going forward and expect CY25 to be stock-picker's market.Headline earnings growth is slowing down, with Nifty FY25 earnings at ~7%, while FY26E estimate stands at ~7%, the lowest in recent times. In such an environment, Quality and Low Volatility factors outperform, which has been the case over the past year.A) Since the pandemic, India Inc. has focused on balance-sheet deleveraging instead of capex investments, which led to lower interest costs.As a result, profit margins and return ratios have significantly improved, which has led to 21% CAGR growth in BSE500 PAT over the last 5-years as compared to ~8% CAGR GDP growth.The other structural factor driving this has been shift in market share from unorganized to organized players across sectors.Formal businesses have gained scale, pricing power, and profitability as informal competitors exited or struggled to comply.Also, growth in employee cost has declined from 9% in June-20 to 5% in Mar'25, which has also been a trigger for high profit growth.A) India has struggled to capitalize fully on the 'China +1 strategy' with NITI Ayog, the government's think tank admitting limited gains so far.Electronics has seen the biggest gains with Apple's plans for continued expansion in India (despite Trump 's threats) highlighting the country's growing foothold in the global electronic supply chain.This has also benefited Indian EMS players which have seen a lot of traction from both import substitution and exports. As China vacates lower value-added manufacturing, textiles, toys, engineering goods, and pharma stand to gain.A) Our GRIP framework (Growth, Risk premium, Inflation and Positioning) suggests a weak outlook for equities and asset allocation in favor of bonds.With earnings growth slowing down (FY26E estimate is one of the lowest starting earnings growth estimates in recent times) and valuations remaining elevated, we do not expect significant outperformance of equities over bonds.Also, risk premium is increasing due to growth slowdown, whereas reduction in inflation makes bonds more attractive.In the long-term, favourable macroeconomic conditions and structural drivers like resilient domestic demand, fiscal consolidation, and global bond index inclusion should support the bond market. Should global uncertainties and geopolitical tensions abate, benign/stable inflation and lower interest rates would remain positive factors.However, Nifty has considerably outperformed bonds over the last decade. While market returns can be volatile in the short-term, equities remain the best-performing asset class over a longer horizon.A) IT exhibits strong seasonality wherein bulk of returns (~17% median) are generated in 2nd half of the year (2HCY>1HCY). There has been marginal improvement in S&P500 CY25E revenue growth, which exhibits a strong correlation with tier-1 IT revenue growth.Also, triggers such as exposure to the Quality factor (outperforms in an earnings growth slowdown environment) & IT index weight at a 16-year low, should lead to IT outperformance in 2HCY25.Global CEO confidence index is at one of the lowest level, which is a strong contrarian indicator for IT outperformance.A) Yes, we are in a stock picker's market. Earnings growth seems to be the key. Stocks with moderate by predictable earnings growth should be preferred over high growth stocks with risk to earnings estimates.From a factor perspective, we prefer Quality and Low volatility stocks which have historically outperformed in an earnings growth slowdown environment.While India's structural story remains intact, we are in a cyclical slowdown at the mid-cycle. Historically, Nifty's earnings estimate trajectory used to be revised downwards each year (~8%) leading up to the financial year but earnings cuts were minimal in this cycle, which have now begun.The government is deploying counter-cyclical tools like repo-rate cuts, CRR cuts, tax relief, and fiscal spending to revive demand and boost growth.A) Elevated geo-political uncertainty led to significant rise in gold prices over the past few quarters. However, we believe that within commodities, its silver's time to shine.The Silver/Gold ratio currently trades at -1 S.D below its LTA (7-year) and we expect mean reversion to manifest & gold to underperform silver in the near-to-median term.Further, industrial demand (accounts for ~50% of total silver use) is surging. Green energy policies globally are amplifying silver's role as a key industrial metal.On the supply side, mine output remains constrained due to high operational costs and lower ore grades. This supply-demand mismatch can further accelerate silver's outperformance in the near-to-medium term.Also, from a tactical perspective, the commodity exhibits a strong seasonality in returns with July historically being the best-performing month.A) SMID profit contribution to the NSE500 universe significantly accelerated since the pandemic but peaked in March-23 at 28%.However, Mcap contribution has remained elevated at ~33% (ATH), while PAT contribution currently stands at 26%. Despite the recent correction, mid-caps and small-caps continue to trade at a significant premium to large-caps as well as their respective 7-year average multiples.Moreover, EPS estimates trajectory appears better in large-caps vs SMIDs. Heavyweight sectors in SMID such as Capital Goods and Chemicals have witnessed significant FY26E earning downgrades in CY25TD.With expensive valuations and deteriorating earnings growth, divergence appears unsustainable. We continue to prefer large-caps over SMIDs, and within large-caps prefer heavy-weights.We don't expect SMID valuation premium to sustain as the built-in growth rate is too high. However, India remains one of the fastest growing economies & over the long-term is likely to outperform EM peers.A) We had been considerably OW on Banks for a long-time, but turned UW last month. Until 4QFY25, BFSI had been the primary driver of Nifty as well as NSE500 earnings growth since Jun'22.However, the trajectory appears to have changed & is expected to continue in FY26E. Large-cap Banks median PAT growth stands at-4% for FY26.At least 2 of 3 key variables, loan growth, NIMs & asset quality, are less optimistic for FY26E, with pressure on NIMs evident. Banks with higher share of fixed-rate/MCLR loan portfolio will benefit and only ICICI/HDFC Bank stand out.From a tactical perspective, Bank Nifty/Nifty ratio touched +2 S.D in June'25, a level from which Banks have historically underperformed the markets in most instances over the following 6-12 months.(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
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