Have things gotten better for stock market investors as we move into 2026, or do you think the new year will look a lot like 2025?
We believe that investors are underestimating the structural benefits that come from an environment of high real growth and low inflation. Low inflation fueled long-term expansions in the US in the 1990s and 2010s, creating real economic prosperity, greater purchasing power, lower interest rates, reliable corporate business planning, anchored inflation expectations, and increased consumer confidence.Looking at where we were a year ago, the Fed was actively pursuing QT. Since a few weeks ago, the Fed has begun monetary liquidity injections worth $40 billion per month and a cycle of rate cuts. Japan has announced a $135 billion stimulus, Germany a €500 billion stimulus, and China is launching targeted stimulus measures. More than 90% of the global central banks we track are in an accommodative mode.
This time last year, investors were optimistic about a new president in the US – a president who would end the war in Ukraine, lower prices in the US and who was seen as pro-growth and pro-business. We all know how that turned out. 2025 was a tumultuous year, with exceptionally high uncertainty and tectonic shifts in trade.
Domestically, India’s growth engine sputtered in October 2024, and Indian stocks heading into 2025 were in the midst of an economic and market correction. Decisive action by the Indian government has led to significant reductions in VAT, tax cuts for the middle class, and the government has stayed the course on infrastructure investment. The RBI has provided useful interest rate cuts and liquidity injections. Following these measures earlier this year, a raft of positive news has emerged since Diwali about improved consumer spending, healthy rural areas, rising incomes and improving credit for small and medium businesses. India has also successfully diverted a large portion of US goods to other countries with tariffs.
Meanwhile, a historic technology boom is underway, with more than $500 billion in capex investments expected by 2026, promising to deliver productivity improvements to enterprises across all sectors. Finally, India has witnessed massive selling by FIs since October last year, to the tune of INR 2.5 lakh crore, and that seems to be waning.
So we think it’s a clearly improved environment heading into 2026.
The word that comes to mind is resilience. India took the best hit the US could deliver on tariffs, shifted trade to other countries and showed resilience with real growth of 8.2% and positive returns on large-cap stocks for the tenth year in a row, as well as positive returns on mid-caps. Things could change quickly once the INR 2.5 lakh crore turnover starts to decline, new money from pension funds finds its way into the markets and initiatives to deepen share ownership through major public and private initiatives gain a foothold.
For Indian equity investors, we expect fundamentals to eventually trump capital flows, as they always do, and there is a good chance this will happen in 2026. 2026 seems to be a decidedly better year than 2025.
Despite all the noise we’ve seen this year, we’re still ending up with around 9-10% upside at the level of the overall index. This would be Nifty’s 10th consecutive year of positive gains. How big is that from an overall perspective for long-term investors?
That’s an exceptionally rare feat in the markets. Typically, markets have a negative year every three years. This data point highlights India’s consistent, structural growth, the government’s continued reform mindset, the country’s strong demographics, as well as the financialization trend driving ever-increasing flows into the markets. In a world where disruption is constant, one must also note that the Nifty has done a commendable job in index updating. This kind of track record gives long-term investors confidence and comfort and invites those investing in low-yield instruments like fixed deposits to consider equities.
But the pain in both smallcaps and select midcaps has unsettled many portfolios. Do you see the market for them improving incrementally in the coming quarters?
Large cap investors were up +11% YTD, quite respectable. After the earnings updates in November, Nifty’s earnings have risen 15.3% year-on-year and earnings revisions are coming through. Heading into 2026, large caps appear well positioned with a broadly diversified mix of companies, old and new, experienced management and bargaining power.
Midcaps – despite stellar earnings growth – are up 5-6%, not bad after two years of strong gains of +24.5% in 2024 and +44.6% in 2023. The price-to-earnings ratio based on best-fit twelve-month earnings has fallen to 27.8 times. For an index delivering growth of over 20% and revisions up 20% year on year, we continue to believe midcaps are well positioned to deliver attractive returns. As we stated earlier, the fundamentals will win out over the flows.
Small caps and micro caps are clear laggards, with returns of -7% and -19% YTD. Furthermore, small cap earnings growth and index revision data don’t look great either. We would seek to build small cap exposure through bottom-up, selective, actively managed strategies through experienced, proven fund managers, rather than index-based passive exposure.
Our strong preference – across all capitalizations – remains actively managed portfolios over passive indices, heading into 2026. We continue to believe that stock and sector selection will be widespread again in 2026, and that stock selection and sectoral, thematic investments will outperform market returns.
Do you think midcaps are better positioned than smallcaps in terms of earnings growth and valuations?
Here’s an interesting fact: midcaps are the best bet when it comes to equity investing in India. They exhibit strong earnings growth and typically much lower volatility than small caps, and consistently high growth compared to large caps. We believe midcaps have strong fundamentals and it is only a matter of time before the market rewards earnings yields and intrinsic value is realized in midcaps.
2026 has the potential to witness the return of inflation, especially in the US. That could create uncertainty and volatility. While we have painted a rosy outlook, one must also keep in mind a plethora of risks that also lurk in the shadows, ranging from supply shocks, inflation, AI trading disappointments, a weakening dollar, debt, etc. Until the macro environment turns decidedly favorable, or we witness improving estimate revisions and earnings numbers in small caps, we prefer midcaps over smallcaps. Our preference for small caps remains a bottom-up, active selection.
Which sectors of the market are you optimistic about in the coming year?
We are generally thematic in our approach to portfolio construction. That worked quite well in 2025, allowing effective coordination with the markets, and we expect it to work again in 2026.
We prefer attractively valued financial securities from the public and private sectors, financial services, consumption, cars and car parts, industrial values, raw materials and IT. We are into platform play in the capital markets as trends in the financial world will accelerate, driven by various private and public initiatives. We like consumption-related new economy plays. We are optimistic about consumption, especially leisure and credit trends. Commodities look interesting, driven by multiple triggers ranging from monetary easing, a weak dollar, a global race to secure resources, the build-out of AI, infrastructure upgrades, the threat of inflation and the attraction and protection of hard assets. Finally, we prefer mid-cap IT names operating in the AI and leading technology sectors. Finally, we have been overweight gold and silver since March 2024 and remain bullish on precious metals.
For someone starting a new portfolio with an outlay of Rs 10 lakh, how much allocation would you recommend in gold, silver, debt and equities?
Assuming the investor has a moderate risk appetite, we recommend an allocation of 12.5% to gold, an allocation of 4-5% to silver and an allocation of 72% to equities (67.5% large cap, 22.5% mid cap and 10% small cap). For the balance of 11%, we recommend a mix of credit, InvITs and term avoidance. Our equity allocation would include a 6-8% allocation to REITs.
What risks should investors consider as they enter 2026?
Our main concern for 2026 is an increase in inflation and rising commodity prices. In addition, the high valuations and high concentration of US technology stocks are a concern as they could impact global markets. Uncertain AI results and excessive spending are additional concerns. In addition, rising interest rates or currency volatility in key developed markets, particularly Japan, pose a risk to the expiration of a very large carry trade. It appears that the US consumer is slowing down, and credit risks and defaults in US markets continue to be concerns as we head into 2026. Finally, the massive global stimulus and monetary expansion has the potential to lead to unintended consequences. At the national level, we cite inflation, policy mistakes and unforeseen geopolitical outcomes as the main risks. Vigilance will remain necessary.
That said, we note that Indian equities, and especially a well-selected portfolio of quality companies with strong business models, earnings visibility, low debt, high ROIC and structural tailwinds, have weathered one crisis after another and consistently delivered great returns. Investors should not let global macroeconomic concerns prevent them from pursuing a long-term wealth creation strategy that meets their risk and return objectives.
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