- Indian markets show potential for a positive run, despite recent volatility.
- Valuations are becoming attractive with cooling markets and cautious sentiment.
- Small caps present a significant opportunity with strong earnings growth potential.
By Mr Arun Patel
Indian markets look like they are set for a positive run. Bull markets start from a position of uncertainty. Recently oil prices have been volatile, the West Asian conflict has disrupted sentiment, global bond yields have risen sharply, and investors remain nervous. Also, we had the growth slowdown that was marked by fiscal consolidation in 2024.
This caused the markets to trend downward in the 16 months or so prior to the war. This is exactly how durable market recoveries begin. Bull markets rarely start when every risk has disappeared. They usually begin when investors are still worried, valuations have cooled, and expectations are low enough for even modest good news to trigger a re-rating.
Why Valuations Are Starting To Look Attractive
India’s share of global profits has moved meaningfully above its index weight, creating one of the widest gaps on record. At the same time, the Sensex looks unusually cheap when measured against gold, suggesting that Indian equities are not expensive when compared with a hard asset that has already had a strong run. Valuations across the Nifty 50, Nifty Midcap 150 and Nifty Smallcap 250 are also trading close to, or below, their long-term averages. That combination of earnings improving, valuations cooling down and sentiment turning cautious is a setup for future returns.
Small Caps Could Be The Bigger Opportunity
The bigger opportunity now is in small caps. This part of the market looks set for a good run in the coming months. Smaller companies have underperformed larger companies over the last 18 months in price terms, but earnings expectations are now improving sharply. FY27 earnings-growth estimates from brokerages suggest small-cap earnings could grow around 20-29 per cent, compared with roughly 13-16 per cent for large caps. This gap is important. When a segment has corrected, valuations have become more reasonable, and earnings growth is expected to be meaningfully higher than the index, the risk-reward then turns attractive.
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The Correction Beneath The Headline Indices
The benchmark indices have hidden the extent of the correction beneath the surface. While the Nifty 50 index had corrected around 15 per cent from its 52-week high, the median stock inside the index had fallen closer to 21 per cent. In midcaps, the index correction was around 15 per cent, but the median constituent correction was about 26 per cent. In small caps, the index was down around 21 per cent, but the median stock had corrected roughly 36 per cent. In simple terms, the average investor has already experienced a much sharper correction than the headline index suggests. This kind of internal market damage often creates the base for the next phase of recovery.
Why IT, FMCG And Realty Struggled
The last financial year was extremely uneven across sectors. IT, FMCG, broader consumption and realty were among the weaker pockets. IT struggled because global discretionary technology spending slowed, US and European clients became cautious, and artificial intelligence created questions about the traditional outsourcing model. When a sector that once commanded premium valuations begins to face slower growth and structural disruption, de-rating follows.
FMCG did badly for a different reason. Volume growth was scattered, urban demand softened, rural demand improved only gradually, and input costs such as palm oil, crude-related packaging and freight hurt margins. Price hikes protected profitability in some cases, but they also hurt affordability and volumes.
Consumption Recovery Still Uneven
Consumption also disappointed because the recovery was uneven. Rural demand showed signs of improvement, but urban consumers were under pressure from high rents, weak salary growth in some white-collar sectors, job uncertainty and elevated household expenses. Many consumption stocks had already priced in a strong recovery. When the actual recovery came through in patches, the sector corrected. Demand was too low for consumption to do well. RBI missed its inflation target by 2.5 per cent, it suggested in the beginning of FY26 that inflation for the year would be 4.5 per cent with upward pressures. The year, in fact, ended at around 2 per cent inflation. This inflation is too low. It suggests demand was weak and corporates were unable to increase prices to consumers, which dampened profitability. RBI has taken measures to correct this for FY27.
Realty Faced Valuation Concerns
Realty was another weak area because valuations had run ahead of fundamentals. Housing demand remained healthy in premium categories, but affordability became a problem after a sharp rise in property prices. The market began to worry that the sector was becoming too dependent on luxury housing, while mid-income and affordable demand remained weaker. In high-beta sectors like realty, even a modest slowdown in growth expectations can cause a sharp stock correction.
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Sectors That Could Lead The Next Rally
Looking ahead, the better opportunity may lie in domestic consumption, export-oriented sectors, PSU banks and autos.
Domestic Consumption
Domestic consumption should improve as inflation cools, liquidity gets better, interest rates ease, and tax/GST changes support household purchasing power. In fact, both the IMF and World Bank increased their FY27 GDP forecast in April 2026, one month into the war, mainly on domestic consumption factors. The key is not to buy consumption blindly. The better opportunity is in categories where volume recovery, premiumisation and operating leverage can come together. After a year of disappointment, even a moderate revival in demand can lead to earnings upgrades.
Export-Oriented Sectors
Export-oriented sectors could become a major surprise. This is also a big factor in India’s recent GDP upgrade by the IMF and World Bank. If the India–US trade deal improves tariff visibility, several sectors can regain competitiveness. Textiles, apparel, gems and jewellery, seafood, chemicals, pharmaceuticals, electrical goods and auto ancillaries could benefit from better access, clearer pricing and improved order visibility. Many of these sectors were punished because of tariff fears and weak global demand. A trade deal can shift the narrative from export risk to export recovery.
PSU Banks
PSU banks remain central to the bullish case. They are the financial transmission mechanism for the next cycle. If consumption improves, retail credit grows. If autos revive, vehicle finance improves. If exports recover, working-capital demand rises. If private capex improves, corporate credit comes back. PSU banks also enter this phase with cleaner balance sheets, better capital positions and more reasonable valuations than many private-sector peers. That gives them both earnings visibility and re-rating potential.
Autos
Autos may be the cleanest expression of the recovery. The sector benefits from lower interest rates, rural demand, premiumisation, replacement demand, exports and improving credit availability. Even if industry volume growth is not spectacular, earnings can improve through better product mix: SUVs, premium two-wheelers, tractors, commercial vehicles, EVs, hybrids and auto exports.
Indian markets do not need a perfect global environment to perform. Earnings upgrades, valuation comfort, improving liquidity and a market that has already priced in a lot of fear are factors that are expected to start a good run. The last year punished expensive, slow-growth sectors. The coming year should reward domestic demand, export competitiveness, PSU banks, autos and selectively, small caps. The wall of worry is still standing, but that may be exactly why the market has room to climb.
(The author is Founder and Partner at Arunasset Investment Services )
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