Valuation excesses, when they happen without fear or worry, are only waiting to be disrupted. The current year began with all-round excesses across asset classes. But it takes barely a few weeks for excesses to diminish significantly.
Often, valuations swing from one extreme to another within months. The velocity of capital flowing into an asset class or out of it determines the extremity of the swings. We are seeing valuations of AI-based businesses swing to extreme highs, and businesses severely affected by AI are trending towards multi-year lows. But will these multi-year lows get worse and reach an extreme position?
Or will we see sanity return to soften the valuation blow on affected businesses like global IT services? Investors who blindly bought the dips in IT stocks are clearly a shaken lot. Many are confused about what they must do now, given the softness in management commentary, lack of adequate long-term guidance, and fear of further disruption. Nobody knows the likely extent of disruption, the extent of job losses, or how the business profile of IT services will evolve.
Primarily, fear of the unknown is weighing heavily on IT stock valuations. This may probably take a much longer time and on-the-ground evidence to settle down. Until then, negative news flows will continue to see overreactions in the stock market. The growing use cases of AI will rattle investors in IT stocks operating in the relevant segments. All this could take valuations of IT stocks significantly below their long-term averages.
This only makes it a huge challenge for the headline indices to sustain at current levels. With most institutional investors overweight on IT and banking, the underperformance in both sectors is going to be a big spot of bother for fund managers. The coming weeks are going to be very significant for the market.
