What makes banks and IT stocks a buy at current levels despite relentless FII selling?

At 17,000, Nifty is trading at around 20 times FY23 earnings. Valuations, even after the correction, continue to be high; but cannot be regarded excessive now. There are some clouds on the horizon like uncertainty created by the Omicron variant of the virus. But, there are plenty of economic silver linings among the clouds, which augur well for stock picking.

Relentless FII selling
The recent market correction has been mainly triggered by relentless selling by FIIs in the secondary market since October. The pace of selling accelerated in November and early December. In October, FIIs sold equities worth Rs 14,475 crore and in November the sell figure exploded to Rs 33,799 crore. In December, up to 10th, FIIs sold shares worth Rs 17,484 crore. (Source: NSDL). It is this relentless selling, more than anything else, that spooked the market.

Overvaluation concerns
In early November, many leading foreign brokerages had downgraded India from overweight to neutral on valuation concerns. India’s PE is 60 percent higher than EM peers and price-to-book value is 100 percent higher than EM peers. Market cap to GDP, too, is excessive at around 120 percent. It is this overvaluation that triggered the downgrade and the consequent sustained selling.

Earnings growth
The silver lining is the positive economic news. GDP growth for Q2 FY22 at 8.4 percent is better than expected. GST collections have consistently improved (Rs 1.31 lakh crore in November), making room for the government to sustain higher expenditure. GFCF (Gross Fixed Capital Formation) has improved to 28 percent of GDP. There are clear indications of uptrend in the capex cycle. India is likely to end FY22 with GDP growth close to 10 percent, making India the fastest growing large economy in the world in FY22. The uptrend in capex cycle can sustain GDP growth rate above 7 percent. Since corporate profit to GDP is on an uptrend, earnings growth of 20 percent for 3 to 4 years is achievable. Seen from this perspective, valuations are not stretched.

The 10 percent correction from the peak has made some segments and stocks attractive. Financials and IT have high earnings visibility and, therefore, are attractive buys at current valuations. Banks have been underperforming in this bull run mainly due to sustained selling by FIIs. In November alone, FIIs sold bank stocks worth Rs 15,606 crore. This was more to do with the portfolio construct of FIIs – banking with assets under custody of Rs 81,8524 crore as on November 30th 2021 constitutes the largest holding of FIIs – rather than any issues in banking. Asset quality issues of banks have receded as reflected in Q1 and Q2 numbers. The credit growth is also picking up. This is the right time to invest in high quality large private sector banks and a couple of leading PSU banks. IT stocks, despite rich valuations, are attractive investment bets even now since the sector is in a multi-year uptrend.

Leading indicators point to smart improvement in the prospects of financials and IT. Credit growth is in double digits for banking majors. The largest mortgage lender has reported the highest ever loan disbursal in October. IT firms are reporting record hiring in recent times. The prospects for banking and IT look bright with good earnings visibility. Therefore, long-term investors can use the correction to buy now into banking and IT, irrespective of the FII activity in the market.