Indian equity markets are positioned for significantly improved performance in 2026 despite experiencing substantial corrections across small and mid-cap segments during 2025, according to Dhiraj Relli, MD & CEO of HDFC Securities. While benchmark indices suggested relative stability, the underlying market pain was considerable, with specific segments facing sharp declines from their recent peaks.

Market Correction Creates Foundation for Recovery

The extent of the correction across market segments reveals the depth of the consolidation phase:

Relli attributes the 2025 consolidation to multiple factors including elevated valuations, trade deal-related uncertainties, a weakening rupee, and persistent foreign portfolio investor (FPI) selling that limited upside potential. However, he believes these corrections have created a healthier foundation for future gains.

Structural Tailwinds Support 2026 Outlook

Several key factors are expected to drive improved market performance in the coming year. Corporate earnings growth, which remained in low single digits during FY25, is projected to accelerate meaningfully to 10-15% over the next two years, providing fundamental support for market appreciation.

Systematic Investment Plan (SIP) flows continue to remain robust, supporting steady domestic demand despite global volatility. Additionally, foreign investors who were net sellers through much of 2025 have shown signs of stabilization in recent sessions. The inflation environment remains manageable, providing the Reserve Bank of India with flexibility to cut rates if economic conditions warrant support.

Selective Approach Required for Smaller Segments

Despite the structural improvements, Relli emphasizes that extreme selectivity remains essential when investing in mid-cap, small-cap, and micro-cap segments. Many stocks that experienced euphoric valuations may not revisit their highs in the near term, requiring investors to maintain discipline across three key areas:

• Valuations: Careful assessment of price levels relative to fundamentals
• Quality: Focus on businesses with strong operational metrics
• Position sizing: Appropriate allocation to manage concentration risk

Relli recommends maintaining 60-65% of portfolios in large-cap stocks with active rebalancing to prevent excessive exposure to more volatile segments. He expects market performance to be stock-specific heading into 2026, with incremental improvement in small and mid-cap stocks likely to be selective rather than broad-based.

Sector Preferences and Investment Strategy

HDFC Securities maintains a constructive view on several key sectors for 2026:

For new investors with ₹10.00 lakh portfolios, Relli advises against chasing recent performance in assets like gold and silver, which have experienced significant rallies. Instead, he recommends focusing on appropriate asset allocation based on individual goals, investment horizon, and risk appetite.

Key Risks and Challenges Ahead

Several risks require careful monitoring as markets enter 2026. Global macro headwinds include escalating US debt levels that could spike global yields and tighten liquidity for emerging markets. Domestically, India faces a critical gap between robust government infrastructure spending and a stalled private capex cycle.

Valuation risks remain acute in mid and small-cap segments, which continue trading at rich multiples well above their 10-year averages. The market has fundamentally shifted from rewarding "growth at any price" to demanding "quality at a reasonable price," meaning companies with weak balance sheets face harsher penalties than in previous years.

Despite these challenges, if corporate India meets earnings expectations, Relli believes the outlook for double-digit returns in 2026 appears not only reasonable but potentially conservative, with the foundation for a strong year already established.

Prateek Agarwal, MD & CEO of MOAMC, expects 2026 to be a year of selective revival for Indian equities, led by earnings growth, improved valuation comfort, and a potential return of foreign portfolio investors (FPIs) after a challenging and narrow market in 2025. Speaking to ET Now, Agarwal outlined his outlook for the Indian equity markets, highlighting key factors that could drive recovery in the coming year.

Indian Markets Decouple from Global Performance

Indian markets underperformed global peers in 2025 despite strong domestic reforms, largely due to heavy FPI selling. While global themes such as defence, renewables, EVs and new-age tech performed well overseas, many of these sectors saw sharp profit-booking in India, leading to a divergence from global trends.

"Valuations were a concern at the start of last year. They are less so now, even though India is still not cheap globally," Agarwal noted. He emphasized that lower global bond yields and a stable rupee could restore market normalcy and attract risk capital back into India.

Recovery Depends on Earnings Growth and Foreign Flows

The pain in midcap and smallcap portfolios stemmed from sustained FPI selling, which triggered selling by HNIs and retail investors, narrowing market breadth. Agarwal believes a reversal will require a combination of strong corporate results and renewed foreign inflows.

"Q2 results were encouraging and Q3 should be better. Markets ultimately follow earnings growth," he said, adding that improved India-US trade relations could act as a sentiment booster for FPIs.

Sector Positioning and IT Outlook

On portfolio positioning, Agarwal said index-heavy leadership could continue if the market remains narrow, as seen with banks and IT services. However, he flagged structural moderation in IT earnings growth, returning to a 5-10% range after a brief post-pandemic surge.

"If growth reverts to sub-10%, valuations should also adjust accordingly. Returns will broadly track earnings growth," he said, suggesting selective opportunities may still exist in mid- and small-cap IT firms with higher growth visibility.

Valuation Premium Remains Defensible

Agarwal acknowledged that Indian equities trade at 1.5-2 times global valuations across sectors, including banks, cement and steel. However, he defended the premium, citing India's demographics, scale, aspiration-led consumption, and long growth runway.

"India offers scale and longevity of growth that very few markets do," he said, adding that in a deglobalising world, companies with strong domestic access deserve valuation support. Interestingly, Agarwal pointed out that many high-growth sectors from 2024 have seen sharp price corrections despite strong earnings growth, leading to meaningful valuation resets. "Some of yesterday's growth stocks now look like value opportunities," he said.

2026 Market Outlook

While cautioning that a calendar change alone does not alter market direction, Agarwal said earnings momentum and valuation compression have improved the risk-reward equation in several high-growth segments. If FPIs return and earnings deliver, 2026 could see leadership broaden beyond a handful of stocks, marking a potential shift from the narrow market conditions experienced in 2025.