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2026: A Better Setup for Earnings Revival Compared to The Last Year
 

2025 in retrospect: The past year was a challenging year for the Indian equity market, with the Indian market underperforming global and emerging markets for the first time since the Covid-19 era. Even with underperformance vs other global markets, our benchmark index Nifty 50 crossing 26,000 milestone after 15 months of consolidations (earlier high was 26,217 on 26th Sep’24). In 2025, the broader market lagged, as the Nifty 50 rose by 10.5% while the Nifty Smallcap 250 fell by 5.6%. The past year tested investor resilience through sharp market rotations, currency volatility, global trade uncertainty, and intermittent foreign capital outflows. Despite all these challenges in the global economy, global equities have delivered strong returns in 2025, supported by AI-led growth themes and policy easing. Safe haven assets like Gold have given staller performance, led by trade uncertainty and major central banks' buying.

On the domestic front, Indian investors demonstrated a proactive and unwavering belief in India’s long-term growth narrative. This faith has been bolstered even more in the last one year, with Domestic investors (DIIs) injecting $88.8 Bn into the Indian equity market while Foreign Institutional Investors (FIIs) taking out $18.7 Bn over the same period. Additionally, the monthly Systematic Investment Plan (SIP) inflow in mutual funds has surged to over Rs 29,000 Cr in Sep’25. This reflects a structural shift in the Indian equity market — from a reliance on FII inflows to a foundation increasingly supported by strong domestic participation. The growing dominance of domestic inflows underscores the deepening maturity of India’s investor base and highlights their unwavering confidence in the country’s long-term growth trajectory.

Indian Economy on the verge of cyclical recovery; however, Global Challenges Likely to Persist: Despite external risks, India’s domestic growth trajectory remains intact, with key macroeconomic factors supporting a stronger FY26 compared to FY25. Both the RBI and the government are providing support by front-loading all pro-growth fiscal and monetary measures to the Indian economy. These developments collectively indicate that our economy is at an inflexion point and will gain benefits in the second half and onwards. All these factors indicate an even better FY27 vs FY26. As we enter CY26, Indian equity markets are transitioning from consolidation to one increasingly driven by earnings visibility, valuation comfort, fiscal discipline, and growth sustainability. However, a key overhang for markets over the past year has been India–US trade and tariff-related uncertainty, which temporarily weighed on export-oriented sectors and foreign investor sentiment. Nonetheless, recent developments indicate progress toward resolution and normalization, reducing tail risks and improving visibility for India’s external trade outlook. A gradual easing of global financial conditions, coupled with stabilizing bond yields, is also expected to improve capital flow dynamics into emerging markets, including India.

Relative Underperformance Provides an Opportunity to Add Equity for the Long Term: In 2025, the Indian market has underperformed the US market and other emerging markets by a notable margin. FTSE India is now trading at a PE premium of 55% to the EM index (PE), vs. an average premium of 44%. During Sep’24, the Indian market traded at a 97% PE premium to EM. And now, after the correction, it is trading at a 55% premium, which looks attractive compared to the past. That said, it is to be noted that relative valuation stabilisation does not necessarily translate into an immediate rally in the current scenario. Markets, in addition to various other developments, are expected to track the following four key parameters: 1) Progress on US trade negotiations, 2) Revival of the earnings growth cycle, which is likely to start from Q3FY26 onwards, 3) Revival in a credit growth cycle, and 4) Transmission of fiscal and monetary benefits into consumption growth.

Style & Sector Rotation - A Key to Generating Alpha Moving Forward: Risk-Reward is slowly building towards Mid and Smallcaps. Nonetheless, recovery will be slow and gradual as we progress in 2026, led by strong earnings expectations, improving domestic liquidity, and stable Indian macros. We believe the market needs to sail through another couple of months smoothly before entering into a concrete direction of growth. As a result, we expect near-term consolidation in the market, with breadth likely remaining narrow in the immediate term. Against this backdrop, our focus remains on Growth at a Reasonable Price, ‘Quality’ stocks, Monopolies, Market Leaders in their respective domains, and domestically-focused sectors and stocks. These, we believe, may outperform the market in the near term. Based on the current developments, we 1) Continue to like and overweight BFSI, Telecom, Consumption, Hospitals, and Interest-rate proxies, 2) Continue to maintain positive view on Discretionary and Retail consumption plays, 3) Prefer certain capex-oriented cyclical plays that look attractive at this point due to the recent price correction as well as reasonable growth visibility in the domestic market in FY26, and 4) Maintain cautious stance on export-oriented sector due to tariff overhang and macroeconomic uncertainties.

We maintain our Top Picks recommendations unchanged for the month as we continue to focus on the thematic approach of superior-quality companies.

Our Key Themes

Key Monitorables in 2026: Most significant events are now behind us, with the majority of negative concerns regarding earnings already factored into the price. Hereon, the market will closely monitor the following global events: 1) Developments in the US government’s policies and negotiations, 2) Further developments in the global AI investment, 3) Further rate cuts by the US FED in 2026 based on the growth and inflation dynamics, and 4) The direction of currency and oil prices.

On the domestic front, a series of domestic events suggests better days ahead in 2026 vs 2025. These are 1) A 50bps CRR cut by the RBI in Dec’24, 2) Consumption boost in the Union Budget, 3) 125 bps of rate cuts by the RBI, 4) Improved liquidity measures by the RBI, and 5) GST 2.0 reforms. These developments suggest a revival of economic momentum in 2026 compared to 2025, which would remain the primary driver of earnings growth for Indian corporates moving ahead. Domestically, the key risk lies not in the intent of policy but in the pace of its transmission. While rate cuts, fiscal relief, and capital spending are already in motion, delayed reflection in corporate earnings could keep investor sentiment cautious. On the positive side, rural demand is showing early signs of recovery. The upcoming Union Budget 2026–27 will be a critical anchor, expected to reinforce the government’s commitment to capital expenditure, fiscal consolidation, and growth-oriented reforms. Continued emphasis on infrastructure, manufacturing, energy transition, and technology-led productivity gains should further strengthen medium-term growth prospects.

We maintained the Dec’26 Nifty target at 28100

We believe the Indian economy remains well-positioned for growth, serving as a stable haven amidst global economic volatility. We remain confident in India’s long-term growth story, supported by its favourable economic structure, rising capex, and the consumption boost from the recent Union Budget and GST 2.0 reforms, driving credit growth for banks. This is expected to support double-digit earnings growth, ensuring that Indian equities can deliver strong double-digit returns over the next 2-3 years. Against this backdrop, we foresee Nifty earnings to post excellent growth of 13% CAGR over FY23-28. Financials will remain the biggest contributors for FY26/27 earnings. However, trade policy uncertainty, rupee depreciation, and delay in earning revival remain key risks to near-term market multiples. In our base case, we maintain the Dec’26 Nifty target at 28100 by valuing it at 20x on Dec’27 earnings. Based on the expectations of the earnings upgrade starting from Q3FY26 onwards, we see upside risk to our target.

The current level of India's VIX is below its long-term average, indicating that the market is currently in a neutral zone (neither panic nor exuberance). While the medium to long-term outlook for the overall market remains positive, we may see volatility in the short run. Hence, we recommend investors maintain good liquidity (10-15%) to use any dips in a phased manner and build a position in high-quality companies (where the earnings visibility is quite high) with an investment horizon of 12-18 months.

Bull Case: In the bull case, we value NIFTY at 21x, translating into a Dec’26 target of 29,500. Our bull case assumption is based on the Goldilocks scenario, which assumes an overall reduction in volatility and a successful soft landing in the US market. The market is keenly watching the global growth scenario in 2026 under Trump's presidency, in which uncertainty related to tariffs is likely to be reduced compared to 2025. Furthermore, private Capex, which has been sluggish for the last several years, is expected to receive a much-needed boost in the upcoming years, with the expectation of policy continuity. Backed by expectations of political stability, policy continuity, fiscal prudence, an improving private Capex cycle, rural revival, and a soft landing in the US market, Nifty earnings are likely to grow at 13%+ CAGR for FY23-28. This would augur well for capital inflows into emerging markets (EMs) and increase the market multiples in the domestic market.

Bear Case: In the bear case, we value NIFTY at 17x, translating into a Dec’26 target of 24,000. We assume the market will trade at above-average valuations, led by the likelihood of a policy shift in the Trump regime. Moreover, we presume that inflation will continue to pose challenges in the developed world. The global market has not seen such elevated interest rates in the recent past. Hence, the chances of going wrong have increased significantly. Nonetheless, the direction of currency, oil prices, and global trade developments will likely put pressure on export-oriented growth in 2026. Moreover, the question mark on the global growth has significantly increased after the imposition of Trump tariffs. These developments will likely bring down the market multiple in the near term. However, based on the recent developments, the chances of this scenario playing out have reduced significantly.

Based on the above themes, we recommend the following stocks: HDFC Bank, Bajaj Finance, Bharti Airtel, Avenue Supermarts, State Bank of India, Max Healthcare, Kirloskar Brothers, Kalpataru Projects, APL Apollo Tubes, Mahanagar Gas, Inox Wind, Prestige Estates, Ujjivan Small Finance Bank, Chalet Hotels, and Sansera Engineering

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