New Delhi [India], September 5 (ANI): India's cyclical recovery faces rising risks from an oil supply shock, fading domestic stimulus and weaker artificial intelligence (AI) capital expenditure, according to a Nuvama Institutional Equities report.

According to the report, the impact of the oil supply shock on corporate margins is expected to emerge from Q2FY27, following a similar lag observed during the 2022 war, when small- and mid-cap companies and cyclical sectors suffered a larger hit to profits. "Inventory gains, which prevented margin contraction in Q1FY27, will reverse from Q2FY27," it said.  

At the same time, AI investment boom is no longer giving a strong boost to financial markets, possibly because the growth in AI-related spending is slowing. As per Nuvama,  if this trend continues, "the positive impact of AI investment on exports and metal prices could weaken from the second half of FY27."

The report also flagged growing concerns that AI investment could slow further. Major technology companies face rising chip costs, stronger competition from China and weaker cash flows, forcing them to rely more on debt to fund their investments. If these pressures continue, the AI investment boom could lose momentum as per Nuvama. 

Notably, the recent slowdown in hardware technology stocks after a sharp rise could also be an early warning sign, similar to what happened before the dot-com bubble burst in 2000. 

"The current stagnation in hardware tech stocks after the meltup is a classic late-cycle sign, la 2000. In the dot-com era, capex bust followed," it said. 

Meanwhile, a hawkish Federal Reserve and rising global bond yields could add to the pressure on risk assets. As per Nuvama, bond yields across the US, Europe, UK and Japan have risen sharply even after adjusting for inflation. The report attributed the increase not only to tighter central bank policies but also to changes in the way US dollars are being recycled globally.

"If left unchecked, it could weigh on valuations of risk assets as well as demand, especially when the consumption and real estate landscape is weak everywhere in the world."

The report further highlighted that the Indian equity market's broadly flat index performance over the past two years masks an unusually high degree of polarisation, with India underperforming emerging markets, large-cap stocks lagging small- and mid-caps, and defensive sectors trailing cyclicals. 

The report attributed the divergence to factors including the artificial intelligence (AI) capital expenditure boom and domestic policy support, with GST cuts and the Reserve Bank of India's regulatory easing boosting goods consumption. 

It said the global AI capex cycle has also supported India's cyclical recovery through machinery exports, metal prices and currency movements, while cyclical sectors and small- and mid-caps have benefited from stronger earnings growth and policy easing. 

However, the report warned, "cyclical recovery needs to broaden to sustain the earnings gap as low hanging fruits of low base have been plucked." (ANI)