Five reasons why Infosys, TCS have outperformed in 2013

IT stocks have witnessed a dramatic reversal in fortunes in a matter of one month. In the three months ending July, the BSE IT benchmark was down over 10 per cent as against a 2 per cent gain in the broader Sensex. Traders stayed away from IT despite rupee weakness as Infosys, Tata Consultancy Services and other big outsourcers were yet to report their quarterly numbers. The U.S. Senate had just passed the Immigration Bill, which had damaging provisions for Indian IT.

But everything changed after Infosys, India's number two IT exporter, reported earnings on July 12. So far in 2013 (year-to-date), IT services has been the best performing sector within the Indian market, Nomura says.

The BSE IT index is currently trading at 52-week high, while Infosys shares hit a 28-month high on Tuesday. Global brokerage Nomura, which had a "reduce" call on Infosys and TCS changed its view and upgraded Infosys to "buy" and lifted TCS to "neutral" on Wednesday.

So, what changed over the last one month?

1) Narayana Murthy's return has lifted sentiments: Infosys shares are trading near a 28-month high even though the company's charismatic co-founder said Infosys will take at least three years to become "desirable" again. Brokerages such as CLSA and Nomura upgraded the stock this month. CLSA said Mr Murthy's track record has ability to meet hurdles. A strong Infosys has the ability to drive confidence through the sector, traders said.

2) U.S. outlook improves: There's strong indication that demand environment in the U.S., the biggest market for Indian outsourcers, has improved. The U.S. accounts for 60 per cent of revenues for tier-I IT firms. Infosys, TCS and Wipro reported better than estimated numbers, while Cognizant raised its full year sales outlook.

"Across companies, commentary suggests FY14 is likely to be a normal year with budgeted spends happening. Net-net, the improvement in outlook in US and discretionary spending is incrementally more positive," Nomura analysts Ashwin Mehta and Pinku Pappan said.

3) Rupee weakness: The rupee continues trading near record lows. Global investment bank Goldman Sachs said the rupee may weaken to 65 by 2016. If the currency continues its downward trend, IT companies will continue to enjoy higher margins. The rupee depreciation also enables Indian firms to become completive while negotiating deals with clients.

4) Uncertainty in stock markets: IT stocks have emerged as a defensive option because they are relatively unaffected by the sharp slowdown in India's economy. IT stocks are trading at a premium to their historical averages, but are at a discount to other defensive sectors such as FMCG and pharma, which gives room for further appreciation in stocks.

5) US Immigration Bill risks have receded: The immigration Bill is likely to get pushed to 2014 with the US House not allowing a vote on the Senate version of the bill, which had all the damaging clauses for Indian IT, Nomura says. That's a short to medium term positive for the entire sector.