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Sharp valuation correction improves risk-reward for Indian equities

After touching an all-time high in Sep’24, the Indian equity market has undergone a prolonged phase of consolidation, marked by both time and price correction. Persistent global, geopolitical and macroeconomic headwinds have heightened volatility across global and Indian markets, dragging down the Nifty-50 by 12% from its 2024 peak, while mid- and small-caps remain nearly flat. Despite the broader market staying range-bound, we examine the key factors shaping market performance and the opportunities emerging amid persistent global headwinds.

* Calm at the surface, active beneath:

While the market remained range-bound and traded below its peak levels, there was significant divergence in sector and stock performance beneath the surface. Sharp sectoral rotation toward segments with a higher representation of mid- and small-caps helped SMIDs outperform, cushioning the impact of a sharper drawdown in large-caps, which limited the broader weakness in Indian indices. Several emerging sectors, particularly in the SMID universe, delivered a strong outperformance, while an ongoing rotation away from established large-caps led to a significant underperformance across several traditional sectors and stocks. Defense (+19%), Metals (+14%) and PSU Banks (+10%) remained the key outperformers, while Technology (-18%), Consumer (-17%), Media (-15%) and Real Estate (-12%) were the key laggards over the past two years.

* Valuations well below the 2024 peak:

Ongoing market consolidation, alongside continued earnings recovery from FY25 lows, has led to a sustained cooldown in valuations from the highs seen in 2024. Notably, large- and mid-caps saw the steepest valuation corrections of 29% and 27% from their highs, respectively, whereas small-caps corrected 4% from the peak on a 12-month forward P/E basis. Notably, the Nifty-50 is now trading 16% below its LPA, while mid- and small-caps are trading 4% and 27% above their respective LPA (vs. trading +20%, +50% and +47% above their respective average in Sep’24). Most sectors are now trading significantly below their Sep’24 peak valuations.

* Institutional flows: A tug of war between FII outflows and DII inflows:

The past two years have witnessed record FII outflows and DII inflows. Strong retail participation, supported by steadily rising monthly SIP contributions (+INR300b per month), provided a cushion against the relentless FII selling. Surprisingly, the sharp FII outflows of USD56b over the past 24 months effectively offset the cumulative FII inflows of the previous eight years, leading to near nil cumulative FII invesesmtnt in the past decade. In contrast, DIIs pumped in a record ~USD177b in Indian equities over the past 24 months, 23% higher than the cumulative DII inflows over the preceding eight years.

* Vibrancy in primary market continues:

India’s primary market has been buoyant in the past two years despite a largely flat secondary market, reflecting sustained investor appetite for new equity issuance and strong participation from institutional and retail investors. Robust IPO activity, led by New-age, Consumer, Manufacturing and Financial companies, highlights the depth of domestic liquidity and continued confidence in India’s long-term growth opportunity. Between Apr’23 and Sep’26, a record INR10.1t was mobilized through public markets, including IPOs, FPOs, OFS and QIPs. At the same time, the vibrant primary market has absorbed a meaningful share of available liquidity, diverting some flows away from the secondary market and contributing to its subdued performance amid a prolonged phase of consolidation. This divergence underscores the resilience of India’s equity ecosystem, where strong capital formation and fundraising activity have continued even as listed equities have remained range-bound.

* Global rate cycle may have limited impact on India:

The surge in global 10-year bond yields and the re-emergence of a rate-hike cycle are key concerns for global equities. The US Fed has raised rates by 25bp to 3.75-4.00%, its first hike in three years, while the BoJ has raised rates twice to 1.25% and the ECB by 25bp to 2.25%. India too is expected to start raising rates from Oct’26. While this may tighten liquidity conditions, the rate-hike cycle is likely to remain shallow, as broad-based inflationary pressure has yet to emerge

* Strength beneath the surface:

Despite ongoing geopolitical headwinds, energy price volatility and bouts of macro uncertainty, India’s economy and corporates have demonstrated resilience during the extreme volatility seen in the past two years. The 7.8% GDP print in 1QFY27, robust GST collections, healthy credit growth, strong auto volumes, and the steady recovery in corporate earnings from the FY25 lows indicate underlying economic strength. A favorable policy environment, active RBI liquidity management, steady DII flows and an estimated ~16% PAT CAGR for both MOFSL Universe and Nifty over FY26-28E provide further support. While a consistent rise in global yields could still trigger volatility and FII outflows, the relatively contained domestic rate cycle, strong liquidity and improving earnings provide buffers against a sharp rate-driven derating in Indian equities. Yet, the underlying strength remains largely underrepresented in the collective returns.

* Market leadership remains firmly bottom-up:

With valuations now significantly below their peaks, earnings growth remaining healthy, and macro environment staying strong, we believe risk-reward has enhanced further for Indian equities. However, given the relatively higher earnings growth in the mid- and small-cap segments, market performance is likely to remain firmly bottom-up. Our top Nifty-50 ideas: Bharti Airtel, ICICI Bank, SBI, Titan, Adani Enterprises, M&M, Bharat Electronics, Eternal, Hindalco, Shriram Finance, Interglobe Avtion., and Apollo Hospitals. Top non-Nifty-50 ideas: TVS Motor, BSE, SBI Funds Management, GE Vernova T&D, Lenskart Solutions, Indian Hotels, Meesho, Dixon Tech, Coforge, Radico Khaitan, Kirloskar Oil Engines, RBL Bank, Physicswallah and Inventurus Knowledge Solutions.

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