Summary:
Entering 2026, equity markets are navigating a complex transition phase marked by elevated long-term interest rates, fiscal dominance in developed markets, and uneven earnings delivery across segments. While headline indices remain near all-time highs, underlying market breadth tells a different story, with meaningful corrections in small-cap stocks and selective pressure even within mid-caps. This divergence reinforces the importance of valuation discipline, asset allocation, and realistic return expectations.
India’s macro fundamentals remain comparatively strong, supported by fiscal discipline, structural reforms, and a stable policy framework. However, equity returns are likely to be driven more by earnings delivery and valuation discipline rather than broad-based multiple expansion. In this environment, large caps appear relatively better placed, while value investing—executed with a strong quality and cash-flow lens—offers a more resilient way to navigate volatility.
Global and Macroeconomic Drivers
Despite aggressive policy rate cuts by major central banks, long-term bond yields have remained elevated. In the US, fiscal expansion and heavy government borrowing have pushed term premiums higher, while inflation remains above target. Japan presents an even starker shift, with bond yields at multi-decade highs, raising concerns around the unwinding of yen carry trades and potential stress in leveraged global positions.
The key takeaway is that fiscal policy, not monetary easing, is now the dominant force shaping long-term rates. While US corporate balance sheets remain healthy after years of deleveraging, government finances are increasingly stretched, with interest costs now rivaling defense spending. This backdrop creates a structurally higher cost of capital and limits the scope for sustained valuation expansion in global equities
Gold and Household Leverage: Indian households are estimated to hold approximately 35,000 tons of gold, valued at nearly 90% of India’s GDP. Due to recent price appreciation, gold purchased over the last decade is now valued at double the original cost. This asset appreciation is notable, as household debt in India has been climbing consistently (reaching 42% of GDP in December 2024), driven particularly by non-housing retail loans. Gold holdings offer Indian households optionality to delever should they choose to do so
AI, Productivity and Growth
AI-led capital expenditure has emerged as a major driver of global growth, particularly in the US and parts of Asia. While the short-term impact on employment remains debated, historical data suggests that higher productivity ultimately supports real wage growth at the aggregate level. However, the distribution of benefits may be uneven across sectors and skill sets.
From a market perspective, the key uncertainty is not productivity gains but whether AI investments will generate commensurate shareholder returns, a question that remains unresolved.
India: Fiscal Discipline and Structural Strength
Unlike several developed economies, India has followed a disciplined fiscal path post-pandemic. Fiscal deficits have been steadily reduced from peak levels, and the government has articulated a clear roadmap to bring debt-to-GDP closer to 50% by FY31. Recent income tax and GST cuts have already supported consumption, limiting further room for aggressive stimulus.
Going forward, growth support is likely to come more from supply-side reforms—such as labor codes, higher FDI limits, and regulatory simplification—rather than large incremental fiscal spending. These measures may not produce immediate growth spikes but improve India’s long-term growth potential and capital formation.
Market Breadth, Earnings, and Valuations
While benchmark indices appear resilient, market internals reveal a stealth correction:
- Large-cap indices are marginally off their peaks
- Mid-caps have held up reasonably
- Small caps have seen sharp drawdowns, with a significant proportion of stocks down more than 30% from highs
This divergence reflects earlier valuation excesses, now translating into weaker forward returns. Earnings growth expectations also appear demanding, with FY27 projections near 17% despite nominal GDP growth closer to 10%, making delivery challenging.
Valuation indicators suggest:
- Large caps: broadly at fair value
- Mid and small caps: still trading at a premium to historical norms
This reinforces the case for moderation in return expectations and a bias toward quality and balance-sheet strength.
Asset Allocation and Style Preferences
Given the current setup:
- Asset allocation and risk management matter more than aggressive positioning
- Large caps offer better valuation comfort relative to mid and small caps
- Hybrid strategies and balanced portfolios appear well suited for this phase of the cycle
- SIP-based long-term investing remains appropriate, but lump-sum equity allocations warrant caution
Value investing, when executed through intrinsic valuation, cash-flow focus, governance discipline, and avoidance of leverage, offers a way to participate without chasing momentum or narratives.
Value Investing: Philosophy in Practice
The value approach discussed emphasizes:
- Buying businesses below intrinsic value, not just low multiples
- Strong filters around balance sheet health, cash-flow generation, and governance
- Avoidance of structural or secularly declining sectors
- A barbell strategy combining cyclical recovery plays and reasonably priced growth franchises
Portfolio construction relies on sector valuation discipline, selective stock picking across market caps, and controlled active risk. Importantly, exits are driven by fundamentals and valuation extremes rather than short-term price movements.
Closing View
Equity markets in 2026 are unlikely to offer easy, broad-based returns. With valuations only partially corrected and earnings expectations still elevated, the environment favors discipline over aggression. A combination of realistic return expectations, large-cap bias, selective value exposure, and balanced asset allocation appears best suited for navigating this phase
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