After a volatile first half of 2026, Indian equities are showing signs of stabilisation as several macro headwinds begin to ease.
However, with valuations still elevated in pockets of the mid- and small-cap universe, investors are increasingly weighing whether the next phase of market gains could favour large caps.
In an interaction with Kshitij Anand of ETMarkets, Saurabh Prasad, Division Head – Research at Mirae Asset Sharekhan, said large caps are now more reasonably valued relative to growth stocks, while the premium commanded by small caps may be difficult to sustain given their more volatile earnings momentum.
He believes any meaningful rotation towards large caps would depend on sustained mid-teen earnings growth, while a revival in foreign flows could further support the segment.
Prasad also highlighted the importance of earnings growth in driving the next leg of market returns, cautioning that select small-cap, defence, PSU and capital-goods pockets leave investors with a lower margin of safety. Edited Excerpts –
Q) After falling in the 1H2026, Indian market is showing signs of stability. How are your reading into market?
A) During 1H2026, Indian equity markets faced multiple headwinds - 1) FII selling due to concentrated AI trade and a strong USD, 2) West Asia crisis raising energy costs for Indian economy, and 3) ~40% monsoon deficit in June.
These soured the sentiments and notwithstanding strong DII support (net buying of ~US$50bn), the markets reacted negatively.
Recently, these headwinds have cooled off. AI trade is reversing, resulting in some FII flows coming to India, thereby supporting the markets.
Even as West Asia uncertainties persist, crude oil prices have somewhat eased relative to where they were three months ago, giving relief to the economy.
Finally, ease in monsoon deficit (dropped to 13% till 24th Aug) and positive corporate earnings momentum in
Q1FY27 has supported the markets. The worst-case scenario is no longer built into outlook, suggesting that a bottom has likely been formed.
Q) Household debt has been rising, and recent figures suggest that it has risen to around 48% of GDP from about 35% a decade ago. Should investors be concerned that consumption has become increasingly credit-dependent?
A) The headline number at ~48% of GDP, although sharply higher than 10 years ago, is still moderate versus other emerging and developed economies. We believe it is unlikely to be a source of systemic risks at current levels.
However, what’s worth focusing are the changing constituents of household debt. Over the years, non-housing retail loans have surged, forming ~60% of total household debt in Sep’25. Consumption loan accounts for almost half of total household borrowing suggesting increasing reliance on credit.
Easy availability of credit, changing attitude towards gold and lifestyle inflation could be contributing to this rise. RBI data indicates borrowing increasingly concentrated in prime borrowers with no deterioration in asset quality.
Nevertheless, we would be watchful as household debt-to-GDP ratio rose by over 250bps during Sep’23-Sep’25. At this pace, any margin of safety would diminish, and an adverse economic shock could lead to stress.
Q) With valuations having moderated but still not looking outright cheap, should investors expect the next phase of returns to come more from earnings growth than from valuation re-rating?
A) With everything else constant, valuation is a function of capital flows and earnings growth. Even after premium compression over the past two years, the current MSCI India 12-month forward valuation premium over EMs is sharply higher than the average historical levels. This would discourage capital rotation towards India.
The Nifty 500 too is near its long period average and hence not outright cheap. A valuation re-rating at current levels would require earnings growth as the most likely catalyst.
We observe some pick-up in earnings since the Dec’25 quarter driven initially by GST rationalisation, commodities/manufacturing and a favourable base.
If earnings growth sustains over next year, it would be key to rise in valuation multiple thereafter. We would also keenly eye the interest-rate trajectory.
Given that CPI is firming up, we expect policy rates to move up in the next six months keeping valuations contained. Hence, returns are likely to be moderate over the next year, subject to sustainability of earnings pick-up seen in recent quarters.
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Q) How are you assessing the earnings outlook for India post Q1 numbers? Are we finally at a point where earnings upgrades can become a meaningful market catalyst?
A) In Q1FY27, Nifty 500 reported revenue and earnings growth of 20% and 9% YoY respectively, suggesting margin compression, majorly driven by the Oil & Gas (O&G) sector. Excluding O&G, earning growth was ~20% YoY.
During the quarter, Banks, NBFC, Metals, Defence, Telecom and Capital Goods were the key earnings driver.
Although the top and bottom-line growth was better than the street expectations, we reckon that the earnings strength was concentrated to a few sectors.
Street is still cautious about upgrades due to the Middle East uncertainty, inflation trajectory and earnings growth sustainability.
Once these factors start to ease along with broad-based earnings recovery, which could take couple of quarters, meaningful earning upgrades in a broader market is expected.
Q) FIIs are slowly turning around but what would it take for FIIs to return decisively to Indian equities? Is it valuations, earnings, the rupee, or a change in global asset allocation?
A) After a four-month sell-off, July saw an inflow which we believe was largely tactical, due to capital rotation away from AI trades. Inflows have continued into August, and some of the aforementioned factors have started playing their roles.
The Nifty 500’s valuations are near long-term averages and earnings too are picking up. Foreign investors would watch earnings momentum to outperform peers for 2-3 quarters, before making long-term investment commitments.
Additionally, sustained earnings growth and rising market cap along with slowing AI trade could increase India’s weight in EM index, bringing in passive flows.
After falling ~9% over previous 12 months, the USDINR is stabilising due to RBI’s moves on FCNR(B) deposits, ECBs and tax relief on G-Secs. We expect US$70-75bn of inflows from FCNR(B) deposits alone.
These would stabilise the USDINR and ease the fall in returns from adverse forex movements, supporting markets
Q) India continues to command a premium over several emerging markets. How much of that premium is justified by India’s growth prospects, and where do you think the market is still pricing in too much optimism?
A) At less than US$3,000 GDP per capita and a population of 1.45bn, India offers both growth and scale. Further, India has historically outperformed other markets on earnings growth, RoE etc. Consequently, MSCI India has commanded long-term average valuation premium (12-month forward) of ~55% over the MSCI EM index.
The premium surged after the COVID pandemic and is yet to ease materially. It was accompanied by earnings growth, which was very healthy until mid-CY24.
A subsequent cooldown is accompanied with moderating valuation gap but is still significantly elevated relative to long term average.
This sticky premium is partly reflected in stretched valuations in select retail-owned pockets such as small/ midcap space and themes including defence and PSUs, lowering margin of safety. These pockets are more vulnerable to earnings disappointments.
Q) Which sectors do you believe can deliver earnings growth above the broader market over the next 2-3 years?
A) Financials would grow with the economy, but we believe the consumer discretionary space would benefit more as disposable incomes rise.
We are also constructive on pharmaceuticals as ~US$300bn of branded drug revenue globally would lose patents exclusivity during CY25-30, creating an opportunity for Indian players including those in complex generics and CDMO.
Capital goods companies dealing with power transmission and distribution, renewable ancillaries and data centres are likely to see healthy earnings growth.
There is strong need to support the 500GW renewable energy target and aggressive upcoming data centre investments.
Defence is an obvious choice (but with rich valuation) where there are domestic and export tailwinds. Significant export opportunity coupled with import substitution has increased defence manufacturing to ~Rs1,500bn currently from Rs 464 bn in FY15.
Q) Do you see a rotation from expensive growth stocks towards more reasonably valued large caps as the dominant market theme?
A) We would use mid/small caps and growth stocks interchangeably. For growth stocks, the growth expectation is the Achilles’ Heel; even a minor disappointment could hurt.
In the past 2 years, domestic inflows in growth stocks outperformed large-caps and FII outflows too were concentrated in large caps. Hence, large caps are now more reasonably valued relative to growth stocks.
Mid-caps have outperformed large caps on earnings in previous 2 years, but we see some loss of momentum in small caps (notwithstanding the Q1FY27 outperformance). Hence, the valuation premium of small caps over large caps may not sustain in the near term.
As we contended earlier, there is likely some capital rotation towards India in the next one year and those could be more concentrated in large caps.
But for the market theme to shift decisively towards them, earnings growth of large cap companies would have to move consistently to mid-teens.
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Q) Mid- and small caps have delivered strong returns over the longer term. How concerned are you about pockets of excess valuation and liquidity risk in this segment?
A) Whenever a segment delivers strong returns in the long term, it is natural to have pockets of excess valuation. Markets tend to outpace fundamentals both on the bullish and bearish sides. That said, market forces ultimately bring them back into balance.
Between mid-caps and small caps, we would be more concerned about the small caps due to relatively volatile earnings momentum.
Moreover, MF inflows are more concentrated in both segments (relative to large-caps) creating surplus liquidity that translate into excess valuation in select pockets such as defence, PSUs, Capital Goods etc., that would be key monitorable for us.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
