As 2025 draws to a close, Indian stock markets find themselves in an unfamiliar position: trailing significantly behind their global counterparts. This underperformance has left investors pondering whether this is a temporary setback or the beginning of a more prolonged trend. Market experts, however, suggest that 2026 is likely to unfold in two distinct phases, with the return of foreign institutional investors (FIIs) acting as the crucial catalyst for a sustained rally.
A Tale of Two Halves: The 2026 Market Trajectory
The year 2025 was marked by global tumult, and its effects were felt on Dalal Street. The Nifty 50 and S&P BSE Sensex rank among the world's worst-performing major indices this year. In stark contrast, South Korea's Kospi soared by 67.5%, Brazil's market gained 31.6%, and Hong Kong's Hang Seng rose 28%.
According to Aashish Somaiyaa, CEO of WhiteOak Capital Asset Management, the coming year is expected to have two clear parts. The first phase will likely see a lack of clear direction, where improving domestic fundamentals and valuations are capped by persistent global headwinds and uncertainty, particularly surrounding US economic policy and politics.
"I wouldn't call it fear but more an expectation that markets are headed for a correction emanating mostly out of US economic and market conditions and US economic conduct," Somaiyaa explained. He anticipates that once this global fog clears, markets could stage a meaningful bounce-back. A significant return of foreign capital, however, may only materialise after a correction in overheated global markets.
The FII-DII Dynamic and Earnings Revival
The behaviour of institutional investors has been a defining feature of 2025. Data from NSDL shows that Foreign Institutional Investors (FIIs) have been inconsistent, net selling in five of the eleven months through November and buying in six. After selling from July to September 2025, they turned net buyers in October and November, only to revert to selling in December up to the 15th.
Domestic Institutional Investors (DIIs), on the other hand, have been steadfast buyers throughout the year, though the pace of their inflows moderated after November. October recorded the strongest DII inflows for 2025.
Nilesh Shah, Managing Director of Kotak Mahindra AMC, identifies corporate earnings growth as the key indicator to watch. He expects a rebound to double-digit earnings growth in FY27, following a muted 2025. This recovery is projected to be anchored by a revival in rural demand, continued government capital expenditure, and a pickup in consumption.
Shah highlights two critical global factors for 2026: whether investors will rotate money away from US assets amid a weakening dollar and policy uncertainty, and whether the rally in Chinese markets will continue to attract foreign capital. "If we are lucky, there could be a return of FII flows as investors book profits in the US and China markets," he said.
Sectoral Preferences and Underlying Risks
In such an environment, stock selection becomes paramount. Kalpen Parekh, MD & CEO of DSP Mutual Fund, believes sector outcomes in 2026 will be driven more by earnings visibility than by market narratives.
Areas linked to domestic investment and manufacturing appear well-placed. Sectors like capital goods, select industrials, and engineering-led businesses offer reasonable visibility, supported by multi-year order books and sustained public capex. Financials remain a core portfolio holding, though the focus is shifting towards balance sheet quality and underwriting discipline over pure loan growth.
Conversely, sectors exposed to global cycles and commodities could face pressure if worldwide demand slows. Additionally, richly valued stocks pricing in high growth may experience heightened volatility.
When asked about the biggest fear for 2026, Kotak's Nilesh Shah pointed to "prolonged global volatility delaying FII return or another earnings downgrade cycle—though risks seem priced in now." Parekh of DSP Mutual Fund warned that the biggest risk is anchoring investment strategies to the previous cycle's trends. The opportunity, he suggests, lies in building portfolios focused on durability—businesses with strong balance sheets, predictable cash flows, and pricing power.
Brokerage firm BofA Securities, in a 3 December report, stated that "risks are skewed to the upside" for Indian markets in 2026, citing potential reforms and a likely reversal in FII outflows. They expect the Nifty 50 to rise by approximately 11% in 2026, with large-cap stocks continuing to outperform small and mid-caps as they did in 2025.
In summary, the Indian equity market steps into 2026 at a crossroads. The first half may test investor patience with range-bound movement, but the foundation for a stronger second half is being laid. The convergence of easing global volatility, a return of foreign capital, and a revival in domestic earnings could well set the stage for the next leg of India's market journey.
