‘FY27 returns to be earnings driven with large caps in focus'

June-quarter results have shown top-line growth, but operating margins have compressed. What is your analysis?

The key takeaway from Q1FY27 is that earnings have been materially better than expected despite a volatile macro backdrop. Nifty profit growth came in at ~18% year-on-year, ahead of expectations, and earnings upgrades were seen across consumer staples, metals and mining and retailing. The market is increasingly gaining confidence in FY27 earnings despite geopolitical uncertainty.

That said, the quality and breadth of earnings are worth watching. A large part of the incremental Nifty profit growth is being driven by commodities, utilities and other global-facing sectors rather than broad-based domestic demand, although the trend is encouraging. Margin pressure remains visible in autos, consumer discretionary and parts of staples.

At current valuations, we are positive on financials and metals. Financials remain inexpensive with stable asset quality and an improving outlook on credit growth, while metal stocks should benefit from a stronger commodity environment. We remain cautious on IT services as demand remains uncertain and artificial intelligence-related spending is still disrupting traditional outsourcing budgets.

What is your view of the AI trade and its impact on India, amid India being Asia's least preferred market?

AI is simultaneously a structural challenge and an opportunity for India. While the traditional labour-arbitrage-based IT/BPO (business process outsourcing) services model may suffer, we can benefit from AI adoption and implementation, enterprise transformation, data centres, power demand, cloud infrastructure, etc.

As far as foreign portfolio investors (FPIs) are concerned, India’s lack of direct exposure to the global AI value chain was just one of the reasons for the FPI outflows. There were other factors, such as weak corporate earnings growth, expensive valuations, high oil prices, a weakening rupee, the equity capital gains tax, etc.

If the rupee stabilizes, driven by foreign currency non-resident (FCNR) inflows and oil prices coming off, and Indian earnings continue to surprise positively, an AI-related global rotation could accelerate FPI reallocation towards India. But I wouldn't build a positive thesis on India only around a global AI trade reversal.

Large-caps have been rangebound, but mid-caps and small-caps have relatively outperformed. Returns for retail over the past two years have been single digits. Do you see this changing from hereon?

There are two main reasons for the relatively weaker performance of large caps (vs small- and mid-caps). First, earnings growth in large-caps has been slower than in most small- and mid-caps, partly driven by base effects and also because small- and mid-caps have greater exposure to India’s faster-growing segments of the economy—data centres, transmission and distribution, consumer tech, aerospace and defence, etc. Second, sustained FPI selling over the past several quarters has disproportionately affected large-caps, where foreign ownership is higher. During this period, strong retail inflows into local small- and mid-cap funds helped this segment.

Going forward, given that most mid- and small-cap stocks are no longer cheap, future returns are likely to be driven more by earnings than by multiple expansion. Large-caps should start participating more meaningfully, given their relatively more attractive valuations and a slowdown in FPI selling. Overall, I would expect significantly greater dispersion between good and bad companies—2023-25 was liquidity-driven; 2026-27 will be more earnings-driven, and that should favour quality large-caps as well as select mid-caps.

What's your view of crude in terms of the lingering West Asia war and its impact on India's balance of payments, and what that means for interest rates?

This remains a key external risk for India. Virtually every strategy discussion over the past few months has revolved around the Iran-US conflict, Strait of Hormuz risks and India's dependence on imported energy. India's macro outlook this year is heavily dependent on how long crude prices stay elevated. Recent FCNR inflows and other capital-account measures provide a useful buffer against external financing pressures, but they do not eliminate the underlying sensitivity of India’s balance of payments to crude oil prices.

We expect USD-INR to remain range-bound within 93-96.5 for the rest of FY27, with the lower end factoring in some room for appreciation should crude prices ease toward $75/bbl, and the upper end at risk if crude were to spike further. The recent RBI monetary policy committee (MPC) minutes raise the probability of rate hikes above an extended pause and reaffirm our call for a 50-basis-point rate-hike cycle, possibly from the December policy, based on continued inflationary risks and uncertainties and the steady compression of real rates.

Two big initial public offerings (IPOs) are expected in the second half of 2026. Do you expect them to suck out liquidity, so the market remains rangebound? Additionally, how do you assess the retail appetite for fresh paper?

IPOs may result in some near-term drain on secondary-market liquidity, although we don't see them becoming a structural market-wide overhang. Mutual funds alone had about ₹1.9 trillion of cash at July-end, while domestic liquidity remains robust. Retail appetite remains strong, but investors have become more valuation-conscious after the past two years' experience. Large IPOs will also attract incremental global capital, although for many institutions, they will partly represent a reallocation within India rather than entirely new money. Ultimately, earnings growth, valuations and global liquidity will be much bigger drivers of market returns than the IPO calendar.

The country's largest private bank is facing corporate governance challenges, and the largest conglomerate is also undergoing a leadership transition amid a focus on new-age sectors. Your comment?

I would distinguish between company-specific issues and systemic implications for the Indian markets. In the case of the leading private-sector bank, governance and board-related developments may create near-term volatility in sentiment, but investors are likely to focus on whether these changes affect business fundamentals, capital allocation, asset quality, and liability franchise. We argue that management and board transitions, by themselves, need not be viewed negatively if they are not linked to underlying operating weaknesses and if succession is orderly. For the large conglomerate, the key questions are succession, capital allocation and whether the group can maintain execution while transitioning towards newer businesses. As long as earnings and strategy remain on track, markets are unlikely to view this as a major risk to the broader market or even for the listed group companies.

Could global climate change affect global markets?

Climate change is already affecting markets, whether through food inflation, insurance costs, water shortages or disruptions to supply chains. For India specifically, investors are paying much closer attention to variables such as monsoon patterns, reservoir levels and agricultural output because they have a direct impact on growth and inflation. At the same time, it is creating investment opportunities. Areas such as power, transmission, renewables and water infrastructure are likely to see sustained capital spending over the next decade. There is also transition risk: companies with high carbon intensity or stranded-asset exposure could face higher financing costs and regulatory pressure. So for markets, climate change is both a risk factor and an investment theme.