Valuations of Indian information technology (IT) stocks have fallen to multi-year lows and may have bottomed out, potentially attracting investors as enthusiasm for artificial intelligence (AI) stocks globally begins to fade, according to Jitendra Gohil, CIO-Listed Equities at Bajaj Alts.
While the broader market has recently fallen 6% to 7%, the IT index has gained 3.5% to 4% as investors shift money into the sector. Large-cap funds and foreign investors are moving some investments away from Asian AI stocks, which have rallied sharply over the past two years.
“When the AI trade starts to fizzle, the Indian IT services company will see some kind of inflows. And this is exactly happening right now,” Gohil said.
However, he does not expect a sharp recovery in the sector immediately. Investors may start buying IT stocks before companies report a full recovery in earnings, but they will look for signs that AI-related revenue is increasing as a share of companies’ total revenue.
Rising US interest rates could threaten AI spending
Higher US interest rates could also put pressure on global AI investments. If inflation and rising oil prices push the yield on 10-year US government bonds to 5.5% or 6%, the cost of investing in AI infrastructure could become less attractive for technology companies.
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Hyperscalers — large technology companies that operate extensive cloud computing infrastructure — have outstanding debt of around $630 billion, according to Gohil.
Apart from Nvidia and, to some extent, Microsoft, most of these companies are generating negative free cash flow after spending heavily on infrastructure. Free cash flow is the money a company has left after paying its operating expenses and capital expenditure.
“It’s a really risky signature sign that look, we have already spent trillions of dollars of this capex and earnings will be back loaded,” Gohil warned.
He said that if US bond yields continue to rise while companies’ cash flows remain negative for an extended period, investors could see a slowdown in AI infrastructure spending and a cut in capital expenditure plans.
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