The Alpha Creators: Bank and IT stocks outperform Nifty50 in the last 11 years

• Banks, the backbone of the Indian economy, and the IT sector have emerged as the alpha creators of the Indian equity markets.
  
• Every year since at least 2012, one of these two critical sectors has beaten the benchmark Nifty50 index – often by a huge margin.
  
• Heading into FY24, analysts find comfort in the strength of Indian banks and Tier 1 IT companies, while the benchmark Nifty50 index could end 2023 on a negative note.
  

Banks, which are the backbone of the Indian economy, and the IT sector have emerged as the alpha creators of the Indian equity markets. Every year since at least 2012, one of these two critical sectors has beaten the benchmark Nifty50 index – often by a huge margin.

The term ‘alpha creators’ refers to securities that generate excess returns when compared to a benchmark without any additional risk.

Together, banks and IT stocks constitute 41% of the market capitalisation of the benchmark Nifty50 index. Of the broader Nifty500 index, these two sectors alone account for 31% of the market capitalisation, underlining their impact on the Indian equity markets.

However, banking and IT stocks have not always moved in the same direction since 2012 – in fact, in 6 out of the 11 years in consideration, these two sectors have moved in the opposite direction.

An analysis by Motilal Oswal has put a number to this stark contrast in the performance of India’s two alpha creators – the average divergence of these two sectors stands at 37%.

“The Bank and IT indices exhibited a stark divergence in yearly returns, with these two indices outperforming alternately over calendar year 2012-22. More importantly, the quantum of relative performance gap between the two sectors was over 40% in 6 out of the 11 years and over 10% in 10 out of 11 years,” said the Motilal Oswal report.

Disruptions lead to higher divergence

The divergence in the performance of these three indices was even more exaggerated during macroeconomic or geopolitical disruptions such as GST, demonetisation, the Covid-19 pandemic and the Russia-Ukraine war.

In fact, since the Covid-19 pandemic, the Nifty IT index has outperformed the Nifty Bank and the Nifty50 indices by a huge margin – at average returns of 22% from 2020 till date, the Nifty IT is far ahead of the Nifty50’s 9% gains, while the Nifty Bank posted 6% returns.

The thesis of banks and IT stocks being alpha creators holds good in the long term, too. The Nifty Bank index has emerged on the top with average returns of 17% from 2012 till date, while the Nifty IT index is a close second at 16%. The Nifty50, on the other hand, has clocked a relatively modest growth of 12%.

Reading the tea leaves: A peek into FY24

Heading into the new financial year, brokerages find comfort in how Indian banks are placed, thanks to attractive valuations and stickier deposits at a time when interest rates are nearing their peaks.

Indian banks have also passed Jefferies’ SVB test – the brokerage said banks are well-placed due to high quality deposits and less reliance on investments in securities.

The other alpha creator – the IT sector – could see some headwinds primarily due to recessionary concerns.

Analysts at Kotak Institutional Equities underlined that the gap between the leaders and laggards of the IT sector will widen in FY24. Tier 1 companies like Tata Consultancy Services (TCS) and Infosys are well-positioned to take advantage of a focus on efficiency, widening their lead over the smaller players in the sector.

As for the benchmark Nifty50 index, analysts now expect it to register a decline in 2023 – it has already wiped out all the gains it had made since September 2021 due to geopolitical tensions, elevated inflation and a higher interest rate regime.

Strategists at the Bank of America have trimmed the target for the Nifty50 by nearly 8% from 19,500 to 18,000 by the end of 2023. The Nifty50 started 2023 at 18,200 points.

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