Equity Outlook CY2026: Reset, Repair, Re rate
Indian equities enter 2026 after a year of sharp divergence between surface-level index returns and underlying investor experience. While headline indices delivered high single-digit returns in CY25, the journey was defined by compressed breadth, weak stock-level outcomes, valuation fatigue in broader markets, and sustained relative underperformance versus global peers. The result has been a market that looks optically expensive in parts, yet fundamentally under-owned, under-loved, and increasingly selective in opportunity.

2025 in Review: Returns Without Comfort
CY25 reinforced a familiar but uncomfortable truth. Index outcomes masked deep internal stress. Despite the Sensex extending its long-term bias toward positive years, stock picking proved unusually difficult. Median drawdowns across NSE500 constituents were severe, randomness outperformed skill for large parts of the year, and mutual fund investor experience lagged headline returns until late in the year. India also materially underperformed both Developed and Emerging Markets in USD terms, driven by a lack of valuation re rating and deliberate INR depreciation acting as a macro shock absorber.

At the same time, domestic investors did not capitulate. SIP flows crossed ₹30,000 crore per month, discretionary flows stayed resilient through corrections, and total domestic equity demand across channels averaged nearly USD 7.5 billion per month. The persistence of flows contrasted sharply with relentless supply from promoters, PE exits, and IPO issuance, creating an absorption problem that kept markets range bound through most of the year.

Why 2025 Played Out the Way It Did
India's macro narrative remained strong, but earnings disappointed. Relative earnings growth versus Emerging Markets slipped below historical averages, even turning negative at points, while EM earnings momentum improved. Valuations entered the year elevated, particularly in mid and small caps where premiums to long-term averages remain meaningfully higher than in large caps. This left little room for further re rating.

External uncertainty compounded the issue. Tariff-related disruptions impaired earnings visibility in export-oriented sectors, prompting FPI outflows and leaving India the most under-owned market among EMs. The RBI allowed the rupee to depreciate, cushioning competitiveness and managing the trade deficit, but at the cost of short-term equity underperformance in USD terms.

What Has Changed Heading Into 2026
The setup into 2026 is materially different. Macro policy has turned decisively supportive. Monetary conditions have eased through rate cuts and CRR reductions. Fiscal policy has pivoted toward growth via tax relief, GST rationalisation, and higher welfare-led spending. A consumption stimulus estimated at USD 70 billion over FY26–27 is set to flow through both rural and urban cohorts.

Consumption is emerging as the dominant growth vector. Rural demand is supported by higher real wages, benign inflation, strong monsoons, and continued social spending. Urban consumption is stabilising, aided by tax relief, softer inflation, and improved credit availability. Digital public infrastructure, particularly UPI, has become deeply embedded, now accounting for nearly 40 percent of private consumption expenditure and acting as a real-time proxy for demand trends.

On the corporate side, profits have normalised to elevated levels. Corporate profits to GDP for Nifty 500 companies have recovered to around 5 percent, well above the long-term average. Earnings growth is expected to re-accelerate into the low-to-mid teens over the next two years, with early signs of positive revisions emerging toward the end of CY25.

Market Structure: Where Risk and Reward Now Sit
The most important structural shift lies beneath the index. Large-cap market share is at a multi-decade low despite an improving share of the profit pool. Conversely, mid, small, and micro caps command historically high market-cap shares even as their profit contribution has peaked and begun to decline. This inversion has materially improved the risk-reward equation for large caps.

Valuation creep remains a reality, but its locus is narrowing. The proportion of stocks trading at extreme multiples remains elevated, yet moderation has begun. Earnings growth across market caps is converging, reducing the justification for persistent valuation dispersion. Market breadth has collapsed to historical lows, reinforcing the case that alpha in the coming cycle will be driven by selection, not exposure.

Sectoral View: Selective, Not Broad-Based
Information Technology sits firmly in the "darkest before dawn" category. Market-cap share has fallen below profit-pool share, a condition seen only twice in the past 25 years. Valuations reflect deep pessimism, while INR depreciation has reduced margin downside risks. Any stabilisation in global demand or currency could act as a powerful catalyst.

Consumer Staples have seen valuation froth meaningfully deflate. Mutual fund ownership is near decade lows. As companies pivot from margin defence to volume growth, urban-focused franchises stand to benefit first from fiscal and monetary easing.

Industrials remain a long-term structural story, but near-term expectations ran ahead of fundamentals. Market-cap share relative to profit contribution has reverted to levels last seen in 2007. A consolidation phase appears necessary before the next leg of the capex cycle asserts itself.

PSUs ex-financials have delivered a strong multi-year re rating, but declining profit-pool relevance limits further upside. The theme is no longer mispriced, even if absolute valuations appear reasonable.

Across factors, growth continues to outperform value, with a visible rotation from value to quality. This aligns with a late-cycle environment where earnings certainty and balance sheet strength command a premium.

Outlook: Measured Optimism
The probability distribution for Indian equities in 2026 has improved. The drag from supply is easing, FPI positioning is extremely light, valuations at the index level are no longer stretched, and earnings momentum is turning. Large caps are positioned to lead, while selective microcaps may surprise where earnings inflect.

Returns are unlikely to be uniform or euphoric. This is a market that will reward discipline, patience, and precision. Earnings, not multiples, will do the heavy lifting. India's share of global GDP and market capitalisation continues to rise, and the next phase of equity returns is likely to be quieter, narrower, and more fundamentally grounded than the last.

Equities are not entering a new bull cycle yet. They are exiting a digestion phase. That distinction matters.

Source: ABSLAMC Research

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