Let’s talk about selling technology overnight. Facebook lost 26%, its biggest sale ever. Mark Zuckerberg is no longer in the top 10 richest people on planet Earth. Do these actions fall under their own weight? Do you think these tech giants are going to have to revise their strategy to incorporate these growth numbers in the future? In the end, it’s the one with the deepest pockets who will win the race, perhaps?
You answered the question. There is the next stage of technological transition; short videos take a lot longer in terms of watch time and as a result the engagement levels and ad rates you can get and revenue start to drop. Some companies are now starting to lose subscribers or rather monthly active users on their apps. This is an imminent technological transition. Perhaps the very reason they re-strategized is because they could see it coming and the market has now woken up.
But at the same time, there are other tech companies that are still holding up and they’ve reported very high numbers. I have to say that this transition is something the market has woken up to and it is perhaps compounded by the uncertainty around interest rates. When we have zero percent interest rates, it doesn’t matter if you have money today or tomorrow or five years later, but if interest rates and real interest rates start to rise , then the question arises whether there is uncertainty in the outlook for the next five or ten years, and then the market starts to panic.
We also see some of it in the Indian space. So, as US bond yields rose, some of the new tech listings saw a very strong sell-off. They have to prove that they can actually generate profits and that is what the market will accept. It’s a mix of those two things. Yahoo was once very successful, then because it couldn’t keep pace with technological change, it slid down. It’s a rapidly changing world. The second problem is that interest rates have changed.
Meta and Instagram are not the same as TCS and an alphabet is surely different from Infosys. Do we also see a long period of consolidation/timing correction in the Indian IT sector? Or is it a knee-jerk reaction that is playing out and perhaps going to be limited to tech companies in the new era, the newly listed universe?
The second argument we gave for the sale is something that applies to the Indian IT space. , so if you measure the Z-score or rather how many standard deviations above them in terms of their average PE, IT space was the most expensive and that’s why we were underweight in the sector. I don’t think it’s the Nasdaq sell-off affecting Indian IT stocks. There may be some minor connections, but that’s just related to the fact that this sector had seen a lot of momentum that had driven it to prices at earnings levels that were perhaps unsustainable and is now experiencing a correction.
We wrote last year that the need to write software and the need for software engineers in India is growing very sharply, but much of this is happening outside of Indian IT services companies. It was in SaaS companies that can generate between $80,000 and $100,000 per person. Offshore IT engineers can generate $35,000 to $40,000 per person and therefore the capacity that a major IT company or a software services company or a technology startup or even captive centers of large banks like ours can pay is, of course, significantly more than an IT services company can pay and therefore their margins and churn would be affected.
Part of it 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 these engineers and so the demand for engineers may possibly exceed the demand from IT service companies and that has been a concern for us. But some of the selling we’ve seen is just high price selling against earnings.
We’ve talked about PE compression and it’s not just in the tech space. Now there are two schools of thought. We may have a situation where it seems expensive now, but in two or three years it may not seem expensive. Is it a pending readjustment or what is considered fair value? It’s not just for IT, it could be for FMCG and it could be someday in the future, even for value stocks.
Totally. So this is where interest rates and the discount rate start to matter. So if one is of the opinion that it makes no difference whether the business is making a profit today or in three or four years, as long as it can grow, the business is rated on how fast it can grow and how much metal or better to the type of metal investment they make, even if they experience losses or need persistent inflows of cash.
These assumptions begin to change when US rate assumptions begin to change. So stepping back, two years back was very difficult for everyone. I don’t mean to criticize policy makers, but each country had to decide what level of monetary and fiscal stimulus to give, because clearly there was going to be a recession as lockdowns were imposed and how much to give.
With hindsight, we can see if too much has been delivered or not enough. In developed economies in particular, which have done a lot of money printing, there has been a surge in cash deposited overnight with the central bank. In the United States, it is 1.5 to 2 trillion dollars. In Europe, it has risen to $4 trillion. In Japan, some people say it’s always been high and it’s been around $4 trillion, which means too much money has been printed.
Fiscally, if you follow retail sales, in almost every major economy other than the United States, retail sales are at or slightly below trend. In the United States, they had risen to 10-11% above trend. These are 6-7 standard deviation events that should not have happened. This means that too much stimulus was delivered. Therefore, regulators, in hindsight, are now realizing that they have to put a stop to it, and as this downturn unfolds, markets find themselves in a very different situation than they were over the past 10 to 15 years, in the sense that with every whiff of weakness, we expected the Fed, the US government, or some major central bank to come in and print money and bail us out.
Right now there is a situation where the demand numbers are starting to drop but policy makers are busy fighting inflation as they are now busy unwinding what they have been doing for the last two years. The markets are not really rooted in that. When this happens, uncertainty about the future increases and it is bad for multiple PEs.
As people are very certain of what will happen, consumer staples and some of the healthcare names are trading at such high multiples due to reasonable visibility on what earnings will be in three or four year. You can’t have that for metals or for oil and that’s why those stocks are trading at lower multiples. When there is greater uncertainty about what may happen over the next two or three years, it is natural to see high PE stocks start to pull away.