Stock markets in India, which had seen a multi-year rally since the pandemic-era crash in March 2020, cooled in 2025. For investors, especially in smallcaps, who were banking on markets continuing to deliver outsized returns, the year has been a reality check. Year-to-date, the BSE Sensex is still up 8 per cent.
However, the smallcap index has declined around 8 per cent, following a massive 500 per cent surge between April 2020 and October 2024, compared to the Sensex’s 200 per cent gains in the same period.
Even as India’s economic growth was strong, sustained pullout from stocks by foreign institutional investors amid a global geopolitical and US-tariff-related uncertainty was among the major reasons behind India’s underperformance versus global markets.
Year-to-date, the MSCI India index has delivered around 4 per cent returns in US dollar terms. That pales in comparison to the MSCI World Index, which is up around 20 per cent, the S&P 500 index in the US is up 18 per cent, and South Korea’s Kospi index has jumped more than 70 per cent.
This year proved to be one of consolidation and recalibration for Indian equity markets, marked by intermittent volatility and global headwinds, according to analysts at Motilal Oswal Financial Services.
“Market movements through the year were largely influenced by global trade dynamics, persistent FII outflows, currency volatility and evolving geopolitical developments,” the analysts said.
Moreover, moderation in earnings growth across select sectors—especially in smallcap stocks—kept markets range-bound.
Will things change in 2026?
A key point to note is that despite the correction this year, analysts point out that midcap and smallcap valuations are still not favourable, compared with large caps.
According to an analysis by Motilal Oswal, the Nifty 50’s one-year forward P/E (price to earnings) stands at 21.5 times, which is around 4 per cent above its long-period average of 20.8 times.
However, the Nifty Midcap 100 and Nifty Smallcap 100 are still trading at P/E multiples of 28.3 times and 25.9 times, representing a premium of 26 per cent and 50 per cent over their respective long-term averages.
“This suggests that largecap valuations are relatively more reasonable after recent consolidation, while midcap and smallcap stocks warrant a more selective approach, with a focus on companies that have strong balance sheets, sustainable cashflows and clear earnings visibility,” the analysts at Motilal Oswal said.
Global factors will continue to drive markets next year, especially the mood among FIIs. Whether geopolitical tensions ease and what happens on the trade front will be key to watch.
Importantly for India, a successful conclusion of trade deals with the US and the European Union will be key to lifting exports. Any positive developments on that front, especially the trade deal with the US, could also help curb the depreciation in the rupee and maybe get FIIs interested in Indian equities again, more so with valuations now far more reasonable than where they were more than a year ago.
The 50 per cent tariffs imposed by the US administration on Indian imports have hurt sectors like gems and jewellery, textiles and seafood. To offset some of the external pressures, the government announced major income tax relief in the Budget last year, which was followed by a massive overhaul of the Goods and Services Tax by the GST council, which cut GST on most daily necessities, apart from cars and two-wheelers, giving consumption a lift.
The Reserve Bank of India’s monetary policy committee also reduced the benchmark repo rate by 125 basis points (1.25 per cent) in 2025. According to Nilesh Shah, the managing director at Kotak Mahindra Asset Management Company, on a $1.5 trillion outstanding loan, the interest rate cuts amount to a saving of around Rs 1.85 lakh crore.
In 2026, the implementation of the 8th pay commission should put more money in the pockets of over 3 crore government employees, which should further boost consumption. Inflation too has been in low single digits, well below the RBI’s 4 per cent target.
At the same time, private capital expenditure still remains tepid amid the global uncertainties.
Shah also pointed out that about 10 per cent of India’s economy is dependent on information technology, business process outsourcing (BPO) and global capability centres (GCC) sectors, and these are vulnerable to disruption by artificial intelligence, which could have a huge impact on jobs.
“Today, India has reached from an excessive premium to its long-term average over China, to just around its historical average. Undoubtedly, Indian markets now offer value vis-à-vis China,” pointed Shah.
He also noted that the Nifty 50 companies’ earnings growth over the last six quarters was in single digits, which may be bottoming out. He feels earnings growth will bounce back in double digits in 2026, which will be driven by consumption, banks and cyclical sectors.
While Nifty 50 is trading now around its historical average, smallcaps are still at a substantial premium, according to Shah.
“Investors must invest in equity based on their asset allocation call, but must moderate return expectation, and they must invest for the long term. The last five-year return in the market was around 16 per cent, led by small and midcaps, giving more than 20 per cent returns. If this is the investors’ expectation in 2026 or financial year 2027, they are likely to be disappointed,” he stressed.