Indian equity markets are experiencing an unprecedented divergence between headline performance and underlying market health. While benchmark indices trade near record levels, a deeper analysis reveals significant stress across the broader market spectrum.

Market Polarisation Reaches Critical Levels

The current market environment presents a stark contrast between surface-level strength and underlying weakness. From a universe of 1,518 listed companies with market capitalisation exceeding ₹1,000 crores, the drawdown statistics paint a concerning picture:

This polarisation has left portfolios under pressure despite the Nifty's resilience. When compared to global markets, India ranks near the bottom among developed and emerging markets for 2025 performance, with indices still hovering around September 2024 levels.

Strong Macro Fundamentals Support 2026 Outlook

Despite current market challenges, India enters 2026 with robust macroeconomic foundations. The economy demonstrates solid GDP growth, controlled inflation levels, and strong domestic consumption supported by policy measures including GST rate cuts. Corporate earnings are expected to witness double-digit expansion both globally and domestically, providing support for current market valuations.

The combination of improving earnings visibility and strong domestic demand creates a favourable backdrop for market recovery. This earnings growth, projected at 10-15% for FY26-27, should serve as the primary trigger for market advancement.

Currency Pressures and Global Dynamics

The rupee's decline beyond ₹85 against the dollar reflects multiple pressures. India's heavy reliance on crude oil imports creates consistent dollar demand, while the widening trade deficit adds further pressure. Foreign investor outflows toward attractive markets like the US, driven by AI sector growth and higher interest rates, have intensified currency weakness.

However, India's strong macroeconomic fundamentals provide significant buffers. Foreign exchange reserves of approximately ₹690 billion, healthy GDP growth, and robust services exports offer protection against extreme depreciation.

Sector Leadership for 2026

Several sectors are positioned to lead the market rally based on earnings recovery and strong domestic demand:

Key Growth Sectors:

• Financials: Rising credit growth, improved asset quality, and margin expansion
• Automotive: Strong demand across mass-market and premium segments
• Infrastructure & Capital Goods: Government focus on roads, railways, and power projects
• Healthcare: Multi-year visibility from increased public spending and insurance penetration
• Consumer Discretionary: Revival in consumption demand supported by lower input costs

The infrastructure sector particularly benefits from significant government capital expenditure, leading to strong order books and visible earnings growth for companies in this space.

IPO Market Momentum Continues

The IPO market achieved a significant milestone with over 100 mainboard offerings raising nearly ₹2 lakh crores. Looking ahead, over 190 companies are in various IPO process stages, collectively targeting potential fundraising exceeding ₹2.5 lakh crores.

Expected IPO sectors for 2026 include technology (fintech, e-commerce), financial services, manufacturing, infrastructure, and healthcare. Strong domestic institutional and retail investor inflows have created substantial capital pools to absorb large issues, though the market is expected to mature with greater focus on fundamentals and realistic valuations.

Key Market Triggers Ahead

Several factors will drive equity market performance in 2026. Corporate earnings acceleration remains the primary catalyst, supported by recovering demand, infrastructure spending, and credit growth. Global factors including AI sector developments, central bank rate cuts, and geopolitical dynamics will continue influencing market direction.

A potential correction in US AI stocks could trigger Foreign Institutional Investor re-investment in India, reversing 2025 outflows. The market's reduced reliance on external capital, supported by strong domestic liquidity, provides a foundation for sustained growth despite global uncertainties.

Indian equity markets are positioned to enter the new year with measured confidence following a year of resilient performance despite notable volatility. Market participants anticipate the upcoming year will be characterized by earnings delivery and selective opportunities rather than broad-based market re-rating, while global uncertainties continue to influence investor sentiment.

Market Performance Review

According to Prateek Nigudkar, Senior Fund Manager at Shriram AMC, the Indian equity markets experienced a challenging but ultimately resilient performance. The year began with significant corrections driven by multiple headwinds that tested market stability.

Despite the early setbacks, benchmarks managed to recover and achieve fresh highs at various points throughout the year. This recovery was primarily supported by strong domestic capital inflows and emerging signs of improving cyclical economic momentum.

Sectoral Performance and Market Dynamics

Large-cap stocks emerged as clear leaders during the market recovery phase. Banking sector stocks and heavyweight information technology companies initially drove the outperformance, followed by consumer-facing companies as spending patterns showed early signs of revival after GST-related policy support measures.

Broader market segments remained more selective, reflecting heightened investor caution regarding stretched valuations and questions about the sustainability of earnings growth across different market capitalization segments.

Capital Flow Patterns and Investment Trends

Capital flows presented a contrasting narrative. Foreign institutional investors maintained a cautious stance, remaining on the sidelines or acting as net sellers for substantial portions of the year. This behavior was influenced by global interest rate dynamics and ongoing geopolitical risks affecting international investment sentiment.

Domestic investors provided crucial market stability during this period. Systematic investment plan inflows remained robust, ensuring consistent capital flow into equity markets even during the most volatile phases. The market successfully absorbed significant supply through large initial public offerings and increased promoter stake sales.

Multi-asset investment strategies gained popularity, particularly as gold and silver rallied to multi-year highs. The precious metals rally helped cushion investment portfolios during a year when equity returns remained relatively modest, reinforcing the importance of portfolio diversification.

Outlook for the Coming Year

Nilesh Shah, Managing Director of Kotak Mahindra AMC, emphasizes that equity returns in the coming year will be anchored in earnings growth rather than valuation expansion. Several positive factors are expected to support market performance.

Mid-cap stocks are viewed as offering relatively better growth potential compared to large-cap alternatives, although market experts caution that performance gaps may remain narrow, making stock selection increasingly critical for investment success.

Export-oriented sectors could benefit significantly if global growth stabilizes and international interest rates ease. Domestic manufacturing and capital goods themes continue to attract long-term investment interest, supported by ongoing infrastructure spending and favorable policy measures.

Investment Strategy Recommendations

Market experts advise investors to maintain balanced portfolio approaches. Fixed income investments are expected to play a larger role in portfolios, offering stability alongside equity investments, while gold and silver may continue providing valuable diversification benefits.

Prateek Nigudkar from Shriram AMC noted optimism for the global macroeconomic backdrop, citing expectations of gradual US Federal Reserve easing, benign energy prices, potential resolution to the Russia-Ukraine conflict, and reduced tariff-related uncertainty.

Motilal Oswal maintains optimistic views on the long-term compounding potential of domestic markets, advising investors to focus on quality businesses and utilize market volatility as opportunities to build exposure to fundamentally strong companies aligned with India's structural growth themes.