Global AI stocks slide on warnings: Can Indian IT stocks sustain its rebound?

As per the latest business developments, Nifty IT index snapped its 6-day losing streak and advanced 4 percent as global AI stocks were rattled after leaders of the biggest AI firms warned of potential risks from the technology. Indian IT stocks Infosys, TCS, HCL Tech and Wipro jumped between 2-5 percent in early session. While the near-term sentimental reaction is positive for IT stocks, market watchers believe the global AI theme will continue being pre-dominant over the medium to long term.

Anthropic CEO Dario Amodei called for a slowdown in the development of frontier AI models, warning that the technology was advancing faster than safety measures could keep pace. OpenAI CEO Sam Altman and other technology leaders have backed the need for greater caution. The comments sparked a sell-off in AI-linked stocks globally, with chipmakers among the biggest casualties.

Pause in AI innovation may work in IT’s favour

“Innovation will need to saturate a bit because till the time it doesn't happen, implementation gets delayed and that's where the opportunity lies for Indian IT,” stated Pankaj Pandey, head of retail research at ICICI Direct. He stated if the pace of innovation continues at the current rate, deflationary pressure on IT services will continue. A moderation in that pace, as a result, could be slightly positive for Indian IT firms.

Pandey believes the opportunity could be better for tier-2 IT firms, as large tier-1 players may deliver only around 3-4 percent dollar topline expansion. With currency tailwinds additionally not providing much backing, smaller IT firms could be better placed, he stated.

Rakesh Vyas, CIO and Portfolio Manager, additionally sees an opportunity emerging from the sharp correction in IT stocks during the past several months. He stated IT firms have increasingly moved towards outcome-based pricing models, which could allow them to benefit as AI moves from experimentation to wider enterprise use.

“As AI models are getting used at the enterprise level, IT firms can use this leverage as small amounts of AI rollout are happening at the enterprise level,” Vyas stated. Firms that can adapt quickly to the new technology and have a softer dependence on traditional legacy systems are likely to do better, he further noted.

That stated, not all market watchers are convinced that the correction alone makes the sector attractive.

“India is predominantly a expansion market,” stated Alok Agarwal, CIO at Alchemy Capital Management. He pointed out that one of the key attractions of Indian equities has been earnings expansion, but that has been missing from the IT index.

“So unless we see elevated expansion returning to the sector and elevated visibility, we keep stay wary,” Agarwal stated. He further noted that while the correction has made IT stocks look more attractive on valuations, the sector needs to demonstrate elevated-teen earnings expansion before the outlook turns more positive.

Valuations stay below historical averages

The sharp correction has, that stated, brought valuations of several large IT stocks well below their historical averages.

TCS is at present trading at around 15x one-year forward PE, compared with its five-year historical average of 28x. Infosys trades at around 14x, against a five-year average of 26x, while Wipro trades at 13x compared with its historical average of 21x.

HCL Tech is trading at around 18x forward earnings versus its five-year average of 24x. Tech Mahindra is relatively closer to its historical valuation at 28x versus a five-year average of 30x.

The softer valuations come after IT stocks had a firm run following the June-quarter results. Infosys, Wipro, Tech Mahindra, TCS and HCL Tech advanced between 8-25 percent over the previous two months, as better-than-anticipated results boosted hopes of a recovery in demand.

Street turns wary after two-month IT surge

That optimism has since moderated, with brokerage views turning somewhat less bullish.

For Infosys, the number of buy/sell/hold recommendations now stands at 29/16/4, compared with 36/13/2 after the March quarter. For TCS, the split is now 29/14/5, against 35/11/5 previously. HCL Tech has additionally noted its buy calls decline to 16 from 22, while sell calls stay at 17.

This suggests that while valuations have become more attractive after the correction, market participants are still waiting for clearer evidence of an earnings recovery.

For Indian IT stocks, as a result, the latest global AI scare may provide some near-term relief after a steep decline. But the bigger question stays whether the sector can turn the rapid evolution of AI from a threat to traditional IT services into a new source of enterprise technology spending.