Indian Markets Head Into 2026 With Caution, Selectivity and Long-Term Confidence: smallcase managers
Mumbai, 16th December 2025: According to smallcase managers, India’s long-term outlook remains firmly positive, underpinned by favourable demographics, policy continuity, rapid urbanisation and sustained productivity gains.
As 2025 draws to a close, Indian equity markets are sending mixed signals. According to the managers, Benchmark indices remain close to record highs, but beneath the surface, the picture is far more nuanced. Valuations are stretched across large parts of the market, smaller stocks are under pressure, and investors are becoming increasingly selective about where they deploy capital. The managers believe that as US growth moderates and the Federal Reserve eventually pivots, interest-rate differentials should increasingly favour Emerging Markets, with India standing out as the most attractive destination. They believe that India’s macro backdrop remains constructive, aided by moderating inflation, the beginning of a rate-cut cycle and continued policy focus on manufacturing, infrastructure and exports. They expect the economy to grow at a steady 6–7% in real terms, with inflation anchored closer to ~4%, implying a phase of more stable, though slightly lower, nominal growth compared to the previous decade.
Dhiren Shah, smallcase manager, Co-Founder, Kamayakya said, “We remain bullish on Indian equities in 2026, with a clear focus on stock selection rather than index levels. While public capex has driven growth so far, the next phase will come from a revival in private capex as corporate balance sheets strengthen and capacity utilisation rises, setting up the next leg of India’s structural growth. Our bottom-up view is anchored on chemicals, infrastructure and manufacturing—sectors that combine policy support with a cyclical recovery.”
The managers note that the ongoing structural reforms—such as GST 2.0, expansion of the PLI framework and enacted direct tax cuts—are strengthening earnings durability rather than fueling short-term growth spikes. At the same time, rising domestic participation through SIP inflows of ~₹30,000 crore per month provides a strong and resilient counterbalance to volatile foreign capital flows.
Vivek Sharma, smallcase manager, Investment Head, Estee Advisors said, “Tariff-related noise from the US, particularly around a potential Trump return, is more of a sentiment and liquidity risk for India than a structural one. It can tighten global liquidity, lift volatility and lead to temporary FII outflows, but it does not change India’s core growth story. At the same time, the AI-led surge in a few US mega-cap stocks has pulled a disproportionate share of global capital, leaving emerging markets under-owned despite stable fundamentals. This has made Indian markets more vulnerable to short-term, flow-driven swings, even as domestic growth and earnings remain on a solid footing.”
Markets in 2025
In 2025, Indian equity performance has been uneven across market segments. Large-cap stocks have delivered relatively stable returns of around 8% YTD, with valuations holding steady at ~22x earnings. This suggests that gains have been driven more by earnings resilience than multiple expansion, reflecting investor preference for stability and balance-sheet strength.Mid-cap stocks have posted modest returns of about 3% YTD, but have seen a sharp valuation reset, with P/E multiples compressing from 43x to 33x. Small-caps have fared worse, declining ~7.5% YTD, alongside a fall in valuations from 34x to 28x. Together, these trends point to tighter liquidity, rising risk aversion and greater scrutiny of earnings quality in the broader market.
Across asset classes, performance has diverged sharply. Gold (INR) has emerged as the standout performer with ~65% YTD gains, reflecting safe-haven demand, currency effects, and geopolitical uncertainty. Emerging markets (MSCI EM) have also performed well, returning around 30%, supported by selective recoveries and capital flows. Developed market equities have delivered solid returns, led by US technology-heavy Nasdaq (22%), followed by the S&P 500 (17%) and European equities (16%). China has seen a moderate recovery at 14%, while India’s BSE 500, at ~4%, has underperformed global peers so far.Foreign investor positioning has also weighed on Indian markets. FIIs have withdrawn ₹1.55 lakh crore from equities in CY2025, with selling accelerating in December on the back of higher US bond yields, a strong dollar and renewed “America First” policies. However, this outflow appears cyclical rather than structural, as a moderation in US growth and an eventual Fed pivot should restore the appeal of emerging markets.
Domestic investors have provided a critical counterbalance. DIIs have absorbed FII selling, buying ₹19,783 crore of equities in November alone, supported by record SIP inflows of ₹29,529 crore in October 2025. This steady domestic liquidity continues to underpin Indian markets despite near-term volatility.
Is valuation still a concern?
According to managers, the market continues to trade at elevated valuations, with nearly 80% of listed stocks currently in the overvalued zone. While strong earnings growth can gradually justify these valuations, investors should be mindful that expensive markets are more vulnerable to sudden “black swan” risks.Historically, short-term returns are harder to generate when valuations are stretched, whereas long-term investing remains far more reliable. Staying invested over a 10-year horizon has consistently delivered better and more predictable outcomes, reinforcing the need for patience and discipline.
Nikhil Gangil, smallcase manager, Founder and CIO, Intrinsic Value notes, " The market, as a whole, is expensive—but that doesn’t mean there are no opportunities. In fact, these are the kinds of markets where patient, long-term investors tend to do better than those chasing quick gains.”
Interestingly, contrary to popular perception, the SME segment appears relatively better valued compared to the broader market. Sectoral analysis suggests pockets of undervaluation in printing, paper, jute, media, oil and banking, where selective opportunities still exist despite the broader market appearing stretched.
What investors should do
The managers note that at the start of 2025, the strong ~18% CAGR delivered over the previous five years has fostered unrealistic return expectations. Though further market conditions offer a lesson to investors to avoid extrapolating recent performance into future expectations. They highlight that rather than focusing on “hot” sectors, emphasis should remain on valuation discipline, as even high-quality businesses can generate poor outcomes when bought at the wrong price. Chasing popular narratives or crowded trades often leads to underperformance, with investors entering themes after valuations have already peaked.
The managers call for investors to have a well-diversified portfolio across asset classes, styles and sectors to navigate volatility and compound wealth steadily over time. They note that investment success should be measured against one’s own goals and risk appetite, not against others who operate under very different constraints.
(Disclosures: At the time of writing this article, author, his clients & dependent family members may have positions in the stocks mentioned above. The author, his firm, his clients or any of his dependent family members may make purchases or sale of the securities mentioned in website. Author may have positions in above stocks so have vested interest obviously in their going up or down as the case may be.
Disclaimer: Investing in any equity is risky. Our recommendations are based on reliable & authenticated sources believed to be true & correct, and also is technical analysis based on & conceived from charts. Investors should take their own decisions. We assume no responsibility for any transactions undertaken by them. The author won't be liable or responsible for any legal or financial losses made by anybody. Investors must take advice from their financial advisors before investing in any stocks.)