In 2025, the domestic market began with a cautious positive approach. This caution stemmed from FII selling activity from October to December 2024, high valuation, a downgrade in corporate earnings due to moderated demand, and a lack of government & private capex. Optimism, meanwhile, was grounded in a vibrant domestic economy, the forecast for reduced interest and inflation rates in 2025, and non-recessionary global pressures. However, the level of optimism diminished as the global “tariff war” extended beyond expectations, causing India to shift from a favourable to an unfavourable tariff list with higher rates. Global risks expanded with the Israel-Hamas conflict, and gold and silver became the best-performing assets. India got most of the impact as FIIs adopted a ‘sell India and buy China’ strategy.

Despite these challenges, India’s large-cap stocks managed a decent 10% return, while small-caps significantly underperformed. This underperformance was a result of declining domestic earnings growth driven by demand moderation and elevated premium valuation. The substantial selling by FIIs impacted overall market liquidity, disproportionately affecting small-cap stocks. Although DIIs injected liquidity, their focus remained primarily on large-cap. Retail investors, conversely, engaged in profit or loss booking, particularly in the latter half of the year, due to the persistent underperformance of the domestic market (loss in patience) and a focus on the IPO market. Issue is that despite price corrections, valuations continued to trade at a premium compared to the broad market.

2026 to be better than 2025 for Indian stock market?

The year 2026 is likely to be better than 2025, as many external risks have been played out and tested by the market. These headwinds are estimated to reverse going forward; for instance, India is likely to sign a trade agreement with the US in 2026. However, this agreement is expected to span over two phases, which could delay immediate benefits. Nevertheless, this resolution is expected to boost the INR, which is currently under stress due to an increased trade deficit.

Importantly, broad corporate earnings have been much better in Q2, and expectations for Q3 remain robust, which will support mid- and small-cap segments. We anticipate selective performance for mid and small-caps in 2026, and long-term investors might consider an accumulation strategy with a 2–3-year view. Nevertheless, we continue to expect that large caps will sustain their outperformance in the medium-term and the broad market will perform selectively because of continued premium valuations and the need for sustained upside in earnings to justify high valuation.

As the year closes, key risks for 2026 include the pending US-India trade deal, elevated Fed rates, the Russia-Ukraine conflict, a potential reversal of the yen carry trade, and persistently high valuations. However, the volatility associated with these risks has reduced. The US is in talks with multiple countries to finalize a deal, and midterm elections (scheduled for November) are expected to pressure the government to reduce inflation. They are already reducing tariffs on many commodities to ease consumer inflation. The market anticipates further rate cuts and moderation of global risks in 2026. India Vix, volatility index has fallen to one year low of 9.5x.

FIIs were net sellers in India, offloading $17.6bn year-to-date (YTD), while buying into other Asian peers such as China and Japan. This was primarily triggered by India’s premium valuation, which has since normalized to below the long-term average, thereby reducing FIIs’ negativity toward Indian assets going forward. Even if FII inflows simply neutralize from negative to neutral, India can perform much better, just driven on by domestic flows.

For 2025, we had suggested a multi-asset strategy with a 60% allocation to equity, 25% to debt, 10% to gold, and 5% to cash. We upgrade the view on equity with a multi-cap approach, increasing the equity mix to 85% (60% large-cap, 15% mid-cap, and 10% small-cap), cutting debt to 10%, and gold to 5%. We hold a target of 29,150 for Nifty50 for December 2026, a return of ~12%.

Disclaimer: This story is for educational purposes only. The views and recommendations above are those of individual analysts or broking companies, not Mint. We advise investors to check with certified experts before making any investment decisions.