CNX IT & Top Constituents – A technical review

While most sectors in the markets are crumbling like nine pins, one sector that has its head high and the flag flying up is the Information technology. The IT sector has been a bulwark against the general market weakness with it performing even as Nifty itself is sliding down.

CNX IT index which is the sector index for Information technology stocks on NSE is now trading at its all time high and is up an astounding 30.4% in this year alone against a loss of 3.8% on the CNX Nifty. But if one were to look at it from a big longer perspective, we can see that it’s just catching up with the returns of Nifty and Bank Nifty

To give a better comparison of the relative strength shown by CNX IT, here is a chart where it’s plotted along with CNX Nifty and Bank Nifty since the beginning of 2012.

As can be seen in the above chart, the Index after being a underperformer since 2012 with respect to Nifty and Bank Nifty is finally catching up. The question that needs to be asked now is whether the outperformance we have seen in the short term can continue.

For that, let’s take a look at the chart of CNX IT Index.

What we can see marked above in the chart is a symmetrical triangle from where the index has currently broken out of. Symmetrical triangles as we all know is a continuation pattern and since CNX IT entered the triangle after a run up, the probability is high that the continuation will be on the upper side as against the lower end.

The target area for the above breakout is easy to calculate given the width of the triangle where the prices have met the trendline. On an conservative basis, this comes to around 1444 points and with the breakout being seen at 7390, a logical target can be 8834. With CNX IT currently standing at 7858, this means another 1000 points, give or take a hundred.

Since the IT Index can go up only if the stocks that are part of it spurt, we need to see how the stocks are behaving and what stocks provide us with the best risk reward relationship.

While the index has 20 stocks as its constituents, the top 5 stocks constitute nearly 91.66% in weight and hence regardless of the performance of the rest, Index move will be determined by these stocks.

The list of the stocks and their weights are as shown below

To be fair, it’s actually top 3 that actually matter since Tech Mahindra and OFSS in total constitute less than what HCL Technologies’ does, but since these stocks are pretty well known and actively traded, it makes a lot of sense to take a look at those too when we are trying to find the best stocks for investment.

Infosys Ltd:

 The man among the boys, Infosys has been there and done that well before many of the other IT sector companies even got incorporated. But time and tide wait for none and with the company unable to keep pace with its competitors, it has more or less been ignored other than for the time when it declares its quarterly results and the stock moves like any penny stock would do.

If we take a look at the monthly chart, (chart below), we can see nothing amiss as such. The stock is in a serious uptrend with it being in a range for some time now. But what it hides is that the range is now in action for 30 months which is a pretty long time for any kind of investor and the area of the range comes to around 850 points which is a pretty large range for even a stock which trades around 2500 (mid point approx of the range). 

While a rectangle pattern is a continuation pattern, in case of Infosys, we seem to be seeing a breakout on the upper side as against a break down on the lower end.  Since a breakout offers a low risk opportunity for entry, a weekly close above3025 should be a ideal place to Buy with a stop below 3000 for a target of 800 points on the upside. Of course, there will always exist risk of a breakdown failure, but since the Risk Reward opportunity is so good, every breakout should be bought into.

Tata Consultancy Ltd:

India’s largest IT company by way of revenues, the chart of TCS shows a clear difference from the chart of Infosys to the extent that one feels that the bus was missed way back and hence it’s a question as to whether the risk – reward relationship is even now in favor of going long.

The stock has been among the leading IT stocks in 2013 with the stock deliver a tremendous return of 47% in the last 7 months. The only big stock that has done better than TCS is HCL Technologies. Both of them have literally run away leaving the IT leader biting the dust.

Coming back to TCS, let’s take a look at the longer term charts.

On the Monthly charts below, we see it gave a breakout at 2 points over the last few years. The first was in late 2009 when it recaptured and went well above the high of 2008 and the second was in mid 2012 when it broke above the range of a few months. While there was barely any retest of the breakout levels in 2009, the stock did offer some opportunity to those who missed the first surge of breakout in 2012 by repeatedly testing the breakout levels.

Currently the stock stands head over heels and with the price in totally unchartered territory with there being not many ways to actually project as to how far it can go from here and whether it will provide any opportunity to enter or is this the most opportune time to enter.

On the weekly charts (below), we can see that TCS has recently broken above an ascending channel. While a breakdown of the ascending channel is a bearish pattern, the breakout on the higher side indicates even more aggressive buying than ever before.

HCL Technologies Ltd:

The chart of HCL Technologies shows a similar pattern to that of TCS with it breaking above all its resistances. The month of July was an excellent month with the stock shooting up a massive 20%. Once again, the question is, have we missed the bus and is there still enough juice left if one were to enter the stock at the current levels.

On the weekly charts, we can see that the current blow off rally started after it broke above 805 where it had consolidated for a few weeks before it saw a slight correction in price.

Tech Mahindra:

With the merger of Satyam Computers into Tech Mahindra, the company has jumped several hoops to emerge as one of the bigger companies dominating the Indian InfoTech sector. The stock which was once seen as a mid cap InfoTech stock with the risk of there being 1 large client (British Telecom) has now seen a total rerating of sorts.

But the rerating has not meant that the stock has gone past its resistances with the stock still trading well below its high of 2007 and hence offers a opportunity to buy on breaks above major resistance zones.

On the monthly charts, we can see that the stock has broken above its resistance area of 1150 and there is not much of resistance above the said zone till it reaches 1750 which is a good 600 points, nearly a 50% move from here.

On the weekly charts, we can also find evidence of a short term cup pattern where the target for the said breakout comes to around 1350.

Oracle Financial Services Software Ltd.

OFSS is the only multinational InfoTech Company listed on the Indian markets. With a very high promoter holding, this stock has been a fancy for quite some time in the hope of the management going with a total buyback (and delisting) which did not happen. It’s also one of the very few companies where revenue occurs purely due to product than service which is the main course for most other InfoTech majors.

Once again, the fact that this stock was clubbed in the mid cap InfoTech segment has meant that there hasn’t been a great run like the ones we saw in TCS and HCL Tech. But that also means that we aren’t chasing the stock at a level where the risks may outweigh the rewards.

On the monthly chart, we can observe that after breaking above its high of 2007, the stock has once again reacted back to the breakout range from where we are seeing a fresh attempt to make new highs.

On the weekly charts, we can see that the stock is making a Head & Shoulder pattern right at the top and one should be wary of it since it’s a very good reversal pattern if the neckline of 2350 gets broken. On the other hand, if the stock moves above 3400, the pattern is invalidated and it would be a fresh breakout.

Conclusion:

The future direction of the InfoTech segment will be led by two factors.

Factor number one is the INR-USD: If Rupee keeps slipping (depreciating) against the greenback, we should expect the stocks to continue with the move higher without much of a break. On the other hand, if the Rupee were to start appreciating against the USD, it would place some pressure on these stocks since they have outperformed for so much of a time and a reversion to the mean (lower) is very much possible.

Of the 5 stocks featured above, our picks in terms of Risk vs. Reward would be in the following order:

*Buy in Infosys is conditional to it breaking above 3025.

Disclaimer: Nothing in this report should ever be considered to be advice, research or an invitation to buy or sell any securities