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The market has undergone a structural and sentimental churn since late 2024. Multiple headwinds like expensive valuation, subdued earnings, FII outflows, tariff uncertainties, absence of an AI story and geopolitical tensions have impacted the market. However, currently Indian equities are nearing the end of a prolonged underperformance phase as most headwinds are showing signs of easing and valuations are now near the averages

• BFSI accounted for the highest FII selling in H1 CY26, largely due to its high index weight, liquidity, and global risk-off flows.

• IT remained the key laggard, reflecting global slowdown fears and pressure on exportdriven earnings.

• On a YTD basis, the Indian equity markets have shown a clear divergence across sectors.

• Cyclical and growth-oriented segments such as Power, Metal, and Defence have outperformed, driven by strong government infrastructure spending, rising demand for energy, and increased focus on domestic manufacturing and defence modernization.

US Monetary Policy: Sticky Inflation Delays Easing

• US inflation is currently above the Fed's target, limiting the scope for rapid policy easing.

• However, moderating labour market momentum and easing commodity prices reduce the probability of additional rate hikes.

• The Fed is likely to remain data-dependent, balancing inflation risks against slowing growth momentum.

• Stable energy prices, lower freight costs and supply chain normalization are expected to support the inflation trajectory.

• If inflation remains sticky, a prolonged higher-for-longer rate environment could delay policy easing and act as a headwind to global liquidity and risk asset flows.

Easing Real Rates Supporting Risk Appetite

• Inflation expectations have risen faster than nominal yields, leading to a decline in real rates.

• Historically, easing real rates have been supportive of risk assets, liquidity-sensitive sectors and selective EM flows.

EM Flows Improving; India Driven More by Domestic Fundamentals

• The US dollar appears to have stabilized as US equity market leadership broadens beyond the AI-driven trade.

• EM flows are likely to remain selective rather than broad-based, favoring markets with stronger growth visibility and macroeconomic stability. India remains relatively well positioned due to robust domestic demand, an improving investment cycle, healthy financial sector balance sheets and policy stability.

• In addition, moderating commodity prices can support corporate margins and earnings growth, particularly across consumption and manufacturing-oriented sectors.

India Stands Out If Global AI Euphoria Moderates…

• The AI-driven rally across Nasdaq, Korea, and Taiwan shows growing concentration risk in a few semiconductor stocks, driven by retail leverage and unresolved capex monetization concerns. If sentiment reverses meaningfully, global fund flows could shift toward more diversified, fundamentals-driven markets such as India.

• Recent RBI measures to attract foreign capital, combined with fiscal support for infrastructure and manufacturing, strengthen the investment case for Indian equities.

• If a turnaround occurs, large caps are likely to get the benefit due to the current favorable valuation.

• For Mid & small caps, a stock and sector-specific approach will be the ideal strategy.

Investment-Led Growth with Inflation in Check…

• India’s GDP is expected to grow ~6.6% in FY27, led by strong domestic demand and government spending. Key downside risks include potential El Niño-related rural weakness.

• While the India–UK FTA and the successful completion of FTAs with the EU and the US will add growth prospects.

• Inflation is expected to rise to ~5.1% in FY27 due to higher input costs but is likely to remain at the RBI’s tolerance level. The easing geopolitical pressures, ample food stocks and normalisation of oil supply from the Gulf are expected to limit the impact.

• The recent acceleration in GFCF, rising to 10.8% in Q4FY26, points to a marked improvement in investment. This may mark the start of the long-awaited private capex cycle, which can accelerate growth

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