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While the Indian stock market has been under pressure over the last two years, it appears extremely polarised now in terms of sector valuations. This could be the moment that can give rise to excellent medium-term alpha-generating opportunities, according to brokerage firm Nuvama Wealth Management. Nuvama pointed out that investors may be extrapolating the recent cyclical earnings recovery into structural gains. However, the changing global macro, weak domestic income dynamics, and extreme valuation gaps between India and other emerging markets, between large caps and small and mid-caps, and between defensives and cyclicals rekindle memories of 2007, 2019, and 2024, when risk-reward flipped heavily in favour of contrarians, said Nuvama. Nuvama underscored that Nifty has underperformed emerging markets over the past five years, similar to what happened in 2013 and 2019. Defensive stocks are now cheaper than cyclical stocks, as was seen before major market turning points in 2007. At the same time, small- and mid-cap stocks are trading at a valuation premium to large caps, close to the levels seen in 2024. Historically, such valuation patterns have often signalled major turning points in the market. According to Nuvama, there are three major factors that have led to the extreme polarisation this time: 1. AI capex: Indian stocks are being valued at a discount because investors fear AI could hurt the IT sector. However, positive earnings are being ignored due to depreciation of the Indian rupee, machinery exports, and metal prices. Nuvama believes the AI capex boom has triggered a cyclical recovery, as two-thirds of India Inc.’s top line is directly or indirectly linked to global trade. 2. Domestic stimulus: While services have stagnated, goods consumption increased due to the GST cuts and the RBI’s regulatory easing. "The listed equities have higher exposure to goods as compared with services, further boosting India Inc.’s top-line growth at a faster pace than the economy," Nuvama explained. 3. Macro cyclical recovery drives earnings polarisation: According to Nuvama, the cyclical recovery reversed the profit underperformance of small- and mid-caps, and cyclicals seen during 2024–25. They are more exposed to AI capex and bigger beneficiaries of RBI’s easing. The brokerage firm believes the cyclical recovery needs to broaden from here to sustain the earnings gap. Nuvama believes the cyclical recovery is at risk now, as it expects margin impact due to supply-related shock to begin from the second quarter of the financial year 2026-27 (Q2FY27) onwards. "Inventory gains, which prevented margin contraction in Q1FY27, will reverse from Q2FY27. Even during the 2022 war, the impact of the oil supply shock showed up with a lag. small- and mid-caps and cyclicals’ profits had a bigger dent," Nuvama said. Another risk is that a poor monsoon, weak incomes, and low credit multipliers may cause domestic stimulus to fade from the second half of the financial year 2026-27 (H2FY27). Moreover, AI capex may no longer reflate risk assets due to deceleration in capex growth, even if current high estimates are met. If this happens, the year-on-year growth impulse from AI capex via exports and metal prices will likely fade from H2FY27 onwards, said Nuvama. Nuvama underscored that bond yields in the US, Europe, the UK, and Japan have risen sharply recently, not only because of hawkish central banks but also due to the new US dollar recycling regime. The brokerage firm said rising bond yields could weigh on valuations and demand for risk assets, especially when consumption and the real estate landscape are weak worldwide. Nuvama believes this could be the time for a contrarian flip. It is overweight in large caps and defensives, including sectors such as IT, private banks, chemicals, internet, consumer, pharma, and cement. It believes the IT sector could also benefit as businesses increasingly adopt AI applications. Some IT companies offer dividend yields of around 5%. All-time low valuations and easing deposit growth pressures make private banks attractive. Bottom cycle margins and a more competitive Indian rupee may result in a turnaround for the chemicals sector. The internet sector is a bastion of growth with still significant scope for profit improvement, said Nuvama. In the consumer segment, Nuvama prefers bottom-up ideas in the discretionary space over staples, while for pharma, it believes defensive characteristics will help in a downturn. In the cement sector, competitive intensity is easing, and input price pressures will peak soon. Cement is one of the best ways to play lower oil prices, said Nuvama. On the other hand, the brokerage firm is underweight on small- and mid-caps and cyclicals, such as industrials, metals, PSU banks, power, and autos. In its model portfolio, IT stocks Coforge, Tech Mahindra, LTIMindtree, and TCS feature, while from the pharma and healthcare space are Sun Pharma, Torrent Pharma, Divi's Laboratories, and Aurobindo Pharma. Nestle, Titan Company, Pidilite, Havells India, and ITC are Nuvama's preferred consumer bets. Coromandel International and Navin Fluorine International are the chemical bets, Grasim and JK Cement are from the cement sector, while Eternal and Bharti Airtel are the preferred picks from the telecom and internet segments. Read all market-related news here Read more stories by Nishant Kumar Disclaimer: This article is for educational purposes only and does not constitute investment advice. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. 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