Nifty IT returns: Relation with USD and Nasdaq

Since the start of the year, Nifty IT has lost 28 per cent

Information technology companies that were once darling of investors during the pandemic period and thereafter have become more untouchable since the start of the year 2022. IT companies on average had generated returns in excess of 300 per cent between April 2020 and December 2021. Nifty IT index proxy to IT company’s share price performance has increased by 303 per cent in the same period compared to 201 per cent by Nifty 50. So, the IT index outperformed Nifty 50 by 50 per cent.

In last five months situation has changed dramatically and we see that performance has interchanged. Since the start of the year, Nifty IT has lost 28 per cent (24-May-2022) while Nifty 50 has lost only around 8.5 per cent. So, fall in the IT index is three times more than Nifty 50. There were various factors that led to such fall in the IT index. First, is higher inflation and subsequently higher interest rate. IT stocks are considered as growth stocks and growth stocks tends to perform better during low interest rate scenario and start underperforming in rising interest rate scenario. Besides, one and half year of vertical rise in the share price of these companies had made them expensive in terms of valuation. Moreover, majority of the IT players have missed the consensus growth expectations and the margin outlook has been moderate. All this led to such underperformance of IT stocks.

Nasdaq and USD

In addition to the above factor, IT company’s share price performance is also influenced by movement of Indian Rupee (INR) against US Dollar (USD) and the performance of tech heavy index NASDAQ. To understand, how the performance of IT gets impacted by USD and returns of NASDAQ, we carried out a study of these factors ranging from start of 2010 to end of April 2022. We took monthly returns of these factors to know the relation between them and how they influence their returns.

The overall correlation between Nasdaq and Nifty IT is positive and they move in tandem 48 per cent of time. Nevertheless, when INR appreciates against USD, it is negative for the Nifty IT index. Below table shows the correlation between all these factors.

The fact is also visible in the following graph where we plotted returns of Nifty IT vs USD/INR and Nifty IT vs Nasdaq. There is upward slopping relation between Nifty IT and Nasdaq while there is slight downward relation between Nifty IT and USD/INR. The reason for such negative relation between the Nifty IT index and USD/INR is because a majority of the earnings for IT company comes in dollar-denominated and hence any appreciation of INR will lead to lower realisation for IT companies and hence lower earnings translating into a negative relationship with USD/INR.

Regression Analysis

To further understand the relation between these factors we run a regression analysis to know how much these factors influence the returns of Nifty IT. Upon regressing monthly returns of these factors on Nifty IT, we find that almost 27 per cent of the Nifty IT returns are determined by these two factors. If we decompose these two factors, we find that 17.5 per cent of the returns come from the movement of Nasdaq and the rest 9.65 per cent is determined by rupee appreciation or depreciation. Both factors are statistically significant. 

Conclusion

IT sector has remained one of the worst-performing sectors in recent times. This is primarily due to their previous run-up (20 months ending December 2021) that has led to an expensive valuation of the sector. Besides, other developments also led to the fall in the IT index. Going ahead, if you want to know the movement of IT companies keep track of Nasdaq and rupee movement against USD. Their movement will help you understand the returns generated by the IT index domestically.