Prime Equity Outlook 2026

Welcome to what might be the world’s least timely—and most honest—2026 equity outlook 😊 While the Street rushed to publish their predictions before the New Year’s confetti settled, we took the contrarian view: actually, watching how 2026 began before telling you what to expect from it. Call it the Rajinikanth school of financial analysis—even when we arrive late, we arrive with style. Now that we have your solid interest with anything we bring Rajnikanth into, let’s talk about what really matters.

“Successful investing is about managing risk, not avoiding it” — Benjamin Graham

The Year Gone By: 2025 Recap

The Indian equity market faced significant headwinds through 2025, with two key structural challenges defining returns:

1. India’s absence from two major global narratives: The artificial intelligence (AI) infrastructure boom and the commodity-driven rally
2. Earnings stagnation and significant foreign investor outflows: Weak nominal GDP growth combined with FPI exits created unfavorable risk-reward dynamics

In addition, the inability to ink a concrete trade deal with US hurt sentiments.

Global Market Performance Divergence

Emerging markets linked to the AI supply chain and commodity resources delivered exceptional returns. Countries such as China, Korea, Taiwan and commodity led Latin American markets including Brazil topped the return charts in 2025 with returns between 30-75% followed by the developed markets like US, Europe and Japan with 20-35% returns. India’s Nifty 50’s return of 9.8% paled in comparison.

A combination of AI trade and geo-political tensions also triggered a major rally in precious metals such as Gold and Silver and in industrial commodities like copper and rare-earth minerals. 

The disparity reveals a concerning rotation: global investors reallocated capital from India’s growth story into regions capturing the AI infrastructure capex cycle and benefiting from geopolitical-driven commodity demand.

India neither being in the AI supply chain, nor in the commodity supply chain plus lack of earnings triggers was caught in a back-foot in this party. This combined with a weak earnings growth and a depreciating currency was not sending an invite to global investors, leading to unfavorable risk-reward. FPI out-flows hit a record high of $18.5 billion in 2025, the second highest since the $16.5 billion reported in 2022.

Although the market ended 2025 on a positive note, the weak breadth was visible with 305 BSE 500 stocks in negative for the year. 

What Lies Ahead: 2026 Outlook Framework

As equity investors navigate 2026, three broad factors will likely determine India’s equity market return trajectory:

1. The US AI Trade: From Capex Boom to Potential Bubble

Current AI contribution to US growth:

Bank of America, JPMorgan, and Vanguard research suggests that AI-related capex has become a material driver of recent US GDP growth. Hyperscaler AI infrastructure spending is currently estimated at approximately 0.8% of US GDP and is projected to exceed USD 500 billion in 2026. This capex is supporting both direct AI equipment orders and indirect demand across semiconductors, data centers, and related infrastructure.

However, critical risk signals are emerging:

• Valuation concentration: US equity markets have become heavily weighted toward a narrow set of AI-focused mega-cap stocks, creating potential vulnerability to sentiment shifts.
• Startup proliferation: A Vanguard research report notes that the US now has 6,956 AI start-ups versus only 4,010 publicly listed companies. This saturation, combined with aggressive venture funding at peak valuations, signals potential for significant capital losses.
• IPO window indicator: When venture-backed companies go public in abundance (as is occurring with AI start-ups in late 2025 and early 2026), historical market patterns suggest late-cycle sentiment concentration.
• Policy uncertainty: Rising regulatory scrutiny around AI safety, data privacy, and labor displacement could dampen capex enthusiasm

Implications for India: Any sell-off in US AI stocks will likely pull down all emerging market proxy plays in the semiconductor, IT services, and electronics manufacturing space and cool the commodity cycle too, to an extent. This could trigger a return of FPI flows to India, which is neither a commodity nor AI proxy but offers strong growth prospects. 

2. Nominal GDP Growth and Corporate Earnings Trajectory

India’s FY26 growth picture:

According to the Ministry of Statistics & Programme Implementation (MOSPI) First Advance Estimates (released January 2026):

• Real GDP growth: 7.4% in FY26 (up from 6.5% in FY25)
• Nominal GDP growth: ~8% (a five-year low)

This divergence is critical for equity investors. While real GDP growth remains robust, nominal growth—which directly drives corporate revenue and profit growth—is at a decade low. This creates a challenging earnings environment. 

In this scenario, only the occurrence of the following events can drive earnings growth: 

• Increase in government spending post-Budget 2026 (contingent on fiscal space)
• Consumption pickup from tax cuts and RBI rate cuts
• Stabilization of export demand if the US trade deal is inked 

Earnings downside risks:

• Fiscal pressure from weak tax collections may constrain government capex guidance in Budget 2026
• Persistent US tariff regime could pressure export-oriented sectors
• Geopolitical volatility could keep commodity prices elevated, pressuring margins for users of commodities without pricing power 

3. Geopolitics and Commodity Inflation

The new era of resource nationalism:

Global geopolitical tensions—centered on Ukraine, Taiwan, the Middle East, and US-China trade friction—are triggering a structural shift toward resource nationalism and defense spending. This creates an upward bias on commodity prices, particularly for critical minerals and rare earths needed for:

• Defense systems and advanced weaponry
• Semiconductor manufacturing (critical minerals)
• Energy transition infrastructure (copper for renewables and EV)

Global defense spending surge:

• Ukraine 2025 defense budget: USD 70.86 billion (doubled within the year due to the ongoing conflict)
• NATO commitment: NATO Foreign Ministers are pursuing a credible path to a 5% GDP defense spending target by 2035, a material increase from historical 2-3% levels
• UK defense support: USD 600+ million committed in 2025 alone for Ukraine air defense, with broader military modernization underway

India’s commodity vulnerability:

India, as a large commodity importer with limited domestic resources in critical minerals, faces:

• Earnings pressure: Commodity inflation directly compresses margins for capital goods, cement, steel, and transportation sectors
• Import costs: Rising copper and critical mineral prices increase production costs for electronics and defense manufacturing
• FPI sensitivity: Volatile commodity backdrop may keep foreign investors cautious unless earnings recovery is visible

What Could Turn the Tide in 2026?

Beyond macro forecasting, three policy actions would materially improve FPI sentiment and domestic earnings prospects:

1. Opening FDI to Chinese Enterprises (Beyond JV Model)

Current status: India currently restricts Chinese investment to joint venture (JV) models (e.g., Haier-Bharti-Warburg deal). Full FDI would unlock:

• Bridge India-China trade deficit: At USD ~100 billion annually, relaxing FDI restrictions could incentivize Chinese manufacturing investment in labor-intensive sectors
• Employment boost: Particularly in textiles, electronics assembly, and light manufacturing
• Technology transfer: Especially in consumer electronics and automotive components

Realistic timeline: Difficult to pin one given geopolitical sensitivities, but could accelerate with a policy pivot.

2. Accelerate US and EU Trade Deal Closures

Current status: India-US and India-EU free trade negotiations are ongoing, with multiple rounds completed. Completion would:

• Reduce tariff drag: Counteract the current 50% US tariff regime on select Indian exports (textiles, leather, jewelry, engineering goods)
• Create supply chain opportunity: EU and US manufacturers seeking China+1 alternatives would prefer tariff-advantaged partners
• Private capex trigger: Tier-1 exporters could accelerate capex in India if tariff certainty improves

Realistic timeline: End of 2026 or early 2027, though a 2026 announcement could trigger positive market sentiment.

3. Fiscal Stimulus and Capex Acceleration

Current status: Weak tax collections limit Budget 2026 fiscal space: However, a credible multi-year capex roadmap (roads, ports, railways, defense manufacturing) could:

• Sustain order book growth for capital goods companies
• Create employment and boost consumption durably
• Signal confidence to FPIs in India’s medium-term growth trajectory

Investing Approach for 2026: Bottom-Up with Macro Discipline

Given the mixed macro backdrop—strong real growth, weak nominal growth, record FPI outflows, and geopolitical uncertainty, we are not budgeting for big index level gains this year. We would rather hunt for bottom-up opportunities with commodity inflation awareness. We do not go with the consensus view that large-caps are ‘safer’ across the board and that midcaps and smallcaps are danger zones. After the rout in the small and midcap spaces, in fact, select buying opportunities could emerge in quality companies from niche sectors only to be found down the market-cap rankings. 

Sector Views

POSITIVE OUTLOOK

1. Financials (Banks & NBFCs)

Rationale:
After earnings compression through FY25-FY26, the sector is positioned for an earnings upcycle in FY27. RBI’s easing on capital requirements, reduced restrictions on lending, and improved provisioning flexibility will allow banks to churn earnings growth in line with credit growth.

System credit-deposit ratio has risen to around 80–82%, a multi-year high that reflects strong credit demand and a tighter funding environment. This backdrop tends to favor well-capitalised banks and leading NBFCs with superior deposit franchises and pricing power, supporting both loan growth and margin resilience into FY27. In this, NBFCs are likely to run ahead of banks with early benefit of cost of funds kicking-in and have recently turned market favorites.

Key risks:

• Regulatory overhang on consumer credit norms and fintech-linked NBFC exposures
• Asset quality deterioration if economic growth disappoints
• Margin compression if deposit costs remain sticky

Selection: Focus on well-capitalized lenders with diversified geographies and customer bases. Avoid over-concentrated retail credit players facing regulatory scrutiny.

2. Consumption (Staples and Discretionary)

A broad consumption tailwind appears to be building from:

• GST rate cuts: Several big ticket items received relief in 2025
• Income tax cuts: Budget 2025 provided tax relief for middle to higher income households
• RBI rate cuts: Multiple rate reductions in FY26 reduced EMI burden on big-ticket purchases. 
• Pay Commission: The upcoming 8^th Pay Commission could add a further boost to discretionary spends 

This can trigger momentum in high-value discretionary purchases (autos, durables). 

Key trends:

• Premiumization: Volume growth modest, but value/ASP growth strong in auto, durables, and alcoholic beverages
• New business models: Disruptive e-commerce, QSR, and modern retail formats gaining share in discretionary categories
• Urban-led growth: While rural demand is benefiting from a robust monsoon, urban and premium pockets are picking up 

Selection: Bottom-up stock picking is critical. Favor companies with:

• Proven premiumization capability
• Pricing power to absorb commodity price hikes 
• Diversified distribution (online + offline)
• Exposure to urban and tier-2/tier-3 growth
• Prudent capital allocation

3. Manufacturing (Including Defense)

Rationale:
India’s manufacturing sector benefits from multiple structural tailwinds:

Global supply chain benefits:

• China+1 policy: Developed market governments and corporations are actively diversifying sourcing away from China
• India’s competitive advantage: Across pharmaceuticals, auto components, electronics assembly, and light engineering
• Tariff advantage potential: If India-US and India-EU trade deals close, India gains tariff preference over Vietnam, Bangladesh, and other EM competitors

Defense and military spending surge:

• Global defense capex: NATO members committing to 5% GDP defense spending by 2035; Ukraine war sustaining elevated defense budgets; India’s own indigenization drive accelerating.
• India’s defense sector: Government pushing for domestic manufacturing through PLI and FDI in defense PSUs; competitive vendors (Bharat Dynamics, HAL, BEL, Larsen & Toubro, Godrej) have multi-year visibility on order books

Sub-sector views:

Selection: Favour companies with:

• Demonstrated competitive advantage in critical supply chains (pharma APIs, precision components)
• Ability to pass on commodity price increases 
• Robust R&D and technology capabilities
• Diversified customer base (not overly dependent on US or single large OEM)
• Disciplined capital allocation
• Emerging defense and indigenous manufacturing order books

4. Commodities as a Defensive Hedge

Rationale:
Given structural upward pressure on commodity prices (geopolitical resource nationalism, AI infrastructure demand, defense spending), investors should consider commodity exposure or commodity-linked ETFs as a portfolio hedge rather than a core overweight.

Rationale for hedge stance:

• Earnings headwind: Commodity inflation pressures margins for commodity-consuming companies (autos, cement, capital goods, pharmaceuticals)
• Inverse return correlation: Commodity rallies during stress periods often provide portfolio ballast when equity drawdowns occur

Rather than large portfolio allocations, a tactical 3-5% allocation to gold-linked or metal ETFs provides downside protection and play on a rally.

Key consideration: This is a hedge recommendation, not an earnings-play recommendation. 

NEUTRAL OUTLOOK

1. Information Technology

Rationale:
Indian IT is caught at the intersection of multiple headwinds that offset secular growth opportunities:

Challenges:

• Visa cost burden: Rising H-1B costs and visa restrictions reduce cost arbitrage for offshore delivery
• AI substitution risk: Generative AI and coding tools are displacing routine development work; junior developer demand declining
• Enterprise budget conservatism: Global enterprise IT spending remains cautious; client digital transformation budgets are contracting

Earnings growth guidance:
Most large IT vendors have guided for negative to low single-digit growth in the near term, with recovery contingent on successful AI monetization and stabilization of client budgets.

Key risks:

• AI monetization uncertainty: Unclear which business models will successfully monetize AI; deal pipelines remain thin
• Competitive intensity: Every IT vendor globally pursuing AI; differentiation will be critical
• Margin pressure: Near-term investments in AI reskilling and platform development will weigh on profitability
• Client budget uncertainty: If US/EU enter recession, enterprise IT spending could contract sharply

We would favour: 

• Vendors demonstrating early AI revenue traction or pipeline momentum
• Companies with niche platforms (not just generic consulting plays)
• Cautious entry points given valuation sensitivity to guidance revisions

2. Pharmaceuticals & Healthcare

Rationale:
Indian pharma enjoys significant competitive advantage in global generic exports but faces policy and competitive headwinds. 

Opportunities:

• China+1 narrative: US and EU procurement teams seeking alternatives to China-dependent supply chains; India is a natural beneficiary
• US Biosecure Act: Passed legislation scrutinizes China-linked supply chains; Indian pharma exporters could benefit from order transfers
• Domestic consumption: Rising affordability and insurance penetration supporting domestic market growth

Headwinds:

• US pricing pressure: Continued generic price deflation in key markets (US accounts for ~40-50% of most exporters’ revenue)
• China+1 benefits lagged: Despite 2+ years of China+1 narrative, China still dominates APIs and key starting materials; India’s uptake slower than expected
• Regulatory overhang: Evolving US drug manufacturing policies and tariff implications create policy uncertainty
• Tariff risk: Current US tariff regime could extend to pharma inputs or exports, adding cost/margin pressure

Healthcare subsector (Hospitals & Diagnostics):

• Performance divergent: Specialty hospital chains with strong capital allocation and regional scaling performing better than commodity generalists
• Capex intensity: Hospital business requires continuous capex for bed additions, equipment upgrades; profitability dependent on utilization and ROCE

We would favour:

• Pure play: Pure play domestic pharma players, including MNC pharma, will stand insulated from this trend and offer opportunities due to strategic tie-ups and business model restructuring. 
• Hospital chains: Specialty-focused operators (cardiac, oncology, orthopedics) with proven capex discipline and unit economics
• Diagnostic chains: Consolidated players with geographic scale and digital/home-collection penetration

CAUTIOUS OUTLOOK

1. Capital Goods

Rationale:
The sector has been primarily fueled by government capex cycle momentum. Recent slowdown signals raise questions about sustainability:

Headwinds:

• Nominal GDP growth deceleration: Weak nominal growth (+8% in FY26 vs +11% in FY25) and tax revenue shortfalls may constrain government capex guidance in Budget 2026[9]
• Fiscal pressure: Central government tax collections underperforming; balance sheet space for large new capex announcements may be limited[9]
• US tariff impact: Capital goods exports to US face tariff escalation; tariffs on machinery and engineering goods can exceed 50%[16]
• Input cost inflation: Copper and other industrial metals at multi-decade highs, pressuring manufacturing margins and capex return profiles[13]

We will favour: 

• Companies with multi-year diversified order books (infra, railways, utilities, defense)
• Vendors with export markets less exposed to US tariff escalation
• Firms showing early signs of private sector order traction. If corporate balance sheets strengthen and profitability recovers, private sector capex could offset government moderation

2. New-Age Tech Listings

Recent years witnessed a surge of venture-backed start-ups listing at elevated valuations with aggressive growth narratives, but several red flags warrant caution. Many prioritize growth over profitability, burning cash or operating at razor-thin margins while facing intense competition from well-capitalized rivals across e-commerce, fintech, and edtech verticals. Repeated capital raises at rich valuations raise concerns about unit economics and capital efficiency, while post-IPO lock-up expirations could trigger selling pressure if operational improvements fail to materialize.

A minority of new-age listings have genuinely improved unit economics and achieved EBITDA profitability—select fintech players with steady-state profitability, e-commerce vertical leaders with consolidated market positions, and niche SaaS platforms with defensible moats merit attention. However, broad sector exposure should be avoided. 

3. Electronics Manufacturing

While electronics manufacturing remains a flagship policy focus with generous PLI schemes and capex subsidies, emerging risks warrant caution.

Investors increasingly question whether current scale achievements can deliver sustainable profitability once subsidies fade, particularly as elevated copper and critical mineral prices pressure margins. US tariff escalations on electronics could limit import substitution opportunities, while rapid technology refresh cycles demand continuous working capital and capex investments.

Focus selectively on vendors demonstrating healthy returns on capital employed excluding subsidies, companies with embedded intellectual property or proprietary manufacturing advantages, manufacturers in critical supply chains with emerging export momentum, and balance sheets strong enough to absorb commodity cost shocks. 

Summary

Given the competing macro currents, we plan adopt the following framework for 2026 instead of our usual market-cap wise forecast. 

1. Bottom-up stock selection with focus on:
   • Strong competitive advantage (China+1, technology, market position)
   • Visible earnings growth trajectory (commodity cost hedges, margin expansion potential)
   • Disciplined capital allocation (Superior ROCE, buybacks only at attractive valuations)
   • Management quality and corporate governance
2. Sector/macro awareness with focus on:
   • US AI bubble risk and potential spillovers to Indian IT/electronics
   • Commodity inflation headwinds on margin-sensitive sectors
   • Earnings recovery timing (likely FY27, not FY26)
   • FPI sentiment tied to US market dynamics and geopolitical developments
3. Risk management:
   • Avoid over-concentration in AI-proxy trades expecting near-term re-rating
   • Hedge against commodity inflation with small tactical commodity positions
   • Monitor tariff developments and adjust export-oriented sector allocation accordingly
   • Maintain dry powder for deployment if valuations compress sharply (esp. if US market sells off)
4. Time horizon: Longer-term (3-5 year) investing may provide opportunities that can compound well. We are confident that the broad-based correction in small and mid-cap stocks which are not visible at the index level, will throw up opportunities to accumulate quality companies. However, investors do need to realize that the period of easy double-digit returns from passive index or all-market investing, may be over. Please read our article on this here:  Why exceptional equity returns have ended 

General disclosures & disclaimers