Strong Retail and Mutual Fund Inflows Cushion FPI Selling, While Defence and Energy Stocks Shine Amid Global Uncertainty

India's broader equity market emerged as the standout performer in the first half of calendar year 2026 (H1CY26), with small-cap and mid-cap stocks comfortably outperforming benchmark indices despite persistent foreign investor selling and global macroeconomic headwinds. Strong domestic institutional participation, resilient retail inflows and improving valuations helped sustain momentum in broader markets, even as the Sensex and Nifty struggled under pressure from heavyweight large-cap stocks.

The Nifty Smallcap 100 Index gained 6.08% during H1CY26, while the Nifty Midcap 100 Index advanced 2.17%. In comparison, the benchmark Sensex and Nifty 50 declined by as much as 10%, reflecting the impact of sustained foreign portfolio outflows and cautious global investor sentiment.

Foreign Investors Continue to Exit Indian Equities

A key factor behind the divergence between large-cap and broader market performance has been the aggressive selling by Foreign Portfolio Investors (FPIs).

During the first six months of the year, FPIs withdrew nearly ₹2.78 trillion from Indian equities. The majority of these outflows were concentrated in large-cap companies, where foreign ownership remains relatively high.

Heavyweight banking, financial services, information technology and blue-chip stocks bore the brunt of the selling, dragging benchmark indices lower despite healthy performance across several mid-sized companies.

Domestic Investors Emerge as Market Stabilizers

While overseas investors remained net sellers, Domestic Institutional Investors (DIIs) stepped in aggressively to absorb the selling pressure.

DIIs invested approximately ₹4.6 trillion into Indian equities during H1CY26, with mutual funds alone contributing around ₹2.9 trillion through sustained inflows.

The continued popularity of Systematic Investment Plans (SIPs), increasing retail participation and growing confidence in India's long-term growth story have significantly strengthened domestic liquidity, reducing the market's dependence on foreign capital.

This structural shift has enabled broader markets to remain relatively resilient during periods of global uncertainty.

Attractive Valuations Spark Buying in Mid and Small Caps

Market experts believe that small- and mid-cap stocks benefited from attractive valuations after undergoing a correction in the previous year.

As earnings visibility improved and balance sheets strengthened across several companies, investors increasingly shifted their focus towards fundamentally strong businesses outside the benchmark indices.

Retail investors, family offices and domestic institutional funds actively accumulated quality mid-cap and small-cap companies, resulting in broad-based gains across numerous sectors.

The improved risk appetite also reflected confidence in India's domestic consumption story and infrastructure-led economic growth.

IT Sector Faces Sharpest Correction

Among all sectoral indices, Nifty IT emerged as the weakest performer during H1CY26, declining nearly 28%.

The sector remained under pressure amid growing concerns over Artificial Intelligence (AI)-driven disruption, slower discretionary technology spending by global clients and uncertainty surrounding future demand for traditional IT outsourcing services.

Additionally, expectations of prolonged high interest rates in developed markets weighed on technology valuations, leading investors to reduce exposure to export-oriented IT companies.

Defence and Energy Lead Sectoral Performance

While technology stocks struggled, several domestic sectors delivered impressive returns.

The Nifty India Defence Index surged around 21%, supported by increased government defence spending, robust order inflows, higher export opportunities and continued policy support under the "Make in India" initiative.

Energy and metal stocks also performed well, benefiting from favourable commodity price movements and continued investments in infrastructure and manufacturing.

Out of more than 1,500 companies across the BSE 500, MidCap and SmallCap universe, approximately 600 stocks generated returns exceeding 6%, while over 100 companies delivered gains of more than 50%, highlighting the strength of the broader market rally.

Macro Challenges Continue to Influence Markets

Despite the resilience shown by broader markets, Indian equities continued to face multiple headwinds during the first half of the year.

These included:

• Persistent foreign portfolio outflows

• Premium market valuations compared with emerging market peers

• Moderating corporate earnings growth

• Geopolitical tensions in West Asia

• Elevated crude oil prices

• Uncertainty surrounding US trade policies

• Weakness in the Indian rupee

• Global investor preference for AI-related technology stocks outside India

These factors limited the upside in benchmark indices while increasing volatility across global financial markets.

Earnings and Policy Developments to Shape H2CY26

Looking ahead, investors will closely monitor several key developments expected to influence market direction during the second half of the year.

These include progress on the proposed India-US trade agreement, global interest rate decisions, geopolitical developments, crude oil prices, inflation trends and the progress of the southwest monsoon.

The upcoming quarterly earnings season will also be crucial in determining whether corporate profit growth can justify current market valuations.

Analysts believe sectors linked to domestic consumption, financial services and healthcare could continue attracting investor interest if earnings remain resilient.

Analysts Prefer Quality Over Momentum

Market strategists expect quality small- and mid-cap companies with strong fundamentals, healthy balance sheets and sustainable earnings growth to continue outperforming over the medium term.

However, they caution investors against indiscriminate buying, noting that valuations in several pockets of the broader market have once again become expensive following the recent rally.

A disciplined investment approach focusing on companies with consistent cash flows, prudent capital allocation and long-term competitive advantages is likely to generate superior returns.

Several brokerage firms continue to favour sectors such as consumer goods, private sector banks, pharmaceuticals, cement, chemicals and selective information technology companies, while remaining relatively cautious on industrials, automobiles, metals and power, where valuations and cyclical risks remain elevated.

Long-Term Outlook Remains Constructive

Despite near-term global uncertainties, India's structural growth story continues to attract long-term investors. Strong domestic liquidity, ongoing infrastructure investment, healthy corporate balance sheets and rising household participation in equity markets are expected to remain important pillars supporting the broader market.

While volatility may persist due to global economic developments, analysts believe disciplined stock selection and a long-term investment horizon will remain the key drivers of wealth creation in India's evolving equity landscape.