Expert view on markets: Nilesh Shah, MD of Kotak Mahindra AMC, says investors should have moderate return expectations from the Indian stock market in 2026. He believes returns will come from selective sectors and stocks rather than a broad-based rally. In an exclusive interview with Mint’s Nishant Kumar, Shah says the worst of valuation excesses could be behind us, even as they are at a substantial premium in the small-cap segment. Apart from the stock market, Shah shared his views on the Indian rupee’s fall, sectors he is positive about, FIIs, and his key expectations from the Union Budget 2026. Here are the edited excerpts of the interview:
Is the worst behind or more pain in the offing?
Markets are near all-time highs, but beneath the index, many stocks are significantly below their peaks. About 73% of Nifty 500 stocks are down more than 10% from their 52-week highs, with pain far more pronounced in mid and small caps than in large caps.
Earnings growth for the Nifty 50 has remained in single digits for six consecutive quarters, which explains the underperformance and FPI selling.
We believe earnings growth is bottoming out and is likely to rebound into double digits in the coming year.
Valuations have corrected from excessive premiums to long-term averages.
This suggests the worst of valuation excesses is behind us, but volatility is likely to remain due to geopolitical risk and return expectations need to be moderated.
What is your outlook for the Indian stock market for 2026?
Indian markets have underperformed emerging market peers in CY25, leading to relentless FPI selling. Their holding is now around 15.6%.
The selling intensity should come down in CY26, and if global capital moves out of America, some flows may come to India.
If Earnings growth bounces back into double digits, it could be driven by consumption, banks, and cyclicals.
Valuations are around historical averages for large caps, midcaps at a marginal premium, and small caps at a substantial premium.
Hence, returns are likely to come from selective participation rather than a broad-based rally.
What should be our strategy for the mid and small-cap segments for 2026?
Mid-caps appear reasonably valued and are expected to outperform the large caps. Small caps, however, are trading at a substantial premium to historical averages.
Our stance is to remain neutral on midcaps and underweight on small caps. Investors should moderate return expectations and not chase momentum in these segments.
If you expect returns like the last five years in small and midcaps, you will be disappointed. High single-digit to low double-digit returns over time may materialise, but not the extraordinary returns of the past.
What sectors are you betting on at this juncture? Are you taking any contra bets also?
From a theme point of view, over the next year, we think financial services with improving growth prospects offer good value.
Consumer discretionary space also looks interesting as the government has put money in the pockets of taxpayers, consumers, borrowers, speculators and will put money in the pockets of government employees.
As income level rises, roti kapda will take lower incremental spending and people will spend more on discretionary.
Banking and financial services, consumer discretionary space, including e-commerce and healthcare, looks interesting from the next 12-month point of view.
If there is a favourable tariff deal with the US, there could be a relief rally in the market temporarily, and then sectors like textiles, gem and jewellery, and aquaculture could bounce back, depending upon how the tariff deal is structured.
Our approach has always been valuation- and earnings-led. Having said that, when markets chase momentum and overpay for growth, discipline itself starts looking contrarian.
Our focus has always been on quality businesses where expectations are low, but fundamentals are improving. Rather than taking sharp contra positions, we are sticking to our core philosophy: don’t chase narratives, don’t fight fundamentals, and let earnings do the heavy lifting.
Over time, that approach often ends up being contrarian at the right points in the cycle.
What is driving the Indian rupee down? Can it fall more?
The rupee has depreciated past 91 largely due to global dollar strength, capital outflows, and India’s net short forward position.
While headline FX reserves are around USD 700 billion, net reserves after adjusting for forward positions are closer to USD 635 billion.
Depreciation has been sharper against currencies like the euro, pound and renminbi, creating export opportunities.
With these forward positions, further pressure on the rupee cannot be ruled out and needs close monitoring.
When do you expect the FIIs to start buying Indian equities?
FIIs have been net sellers due to India’s underperformance versus peers, single-digit earnings growth, US tariffs, and heavy IPO supply.
Their ownership has declined to about 15.6%. We expect selling intensity to come down in CY26, with FIIs likely turning buyers in FY27 as earnings growth rebounds into double digits, valuation premium versus China and EM normalises, and global capital potentially reallocates away from the US.
What are your key expectations from the Union Budget 2026?
The Union Budget 2026 requires out-of-the-box thinking to balance fiscal prudence with the expenditure pressures arising from the 8th Pay Commission.
One credible solution lies in monetising idle household gold and silver. Defreezing these assets and bringing them into the financial system can raise government resources, support consumption and investment, and help meet fiscal targets without destabilising the macro framework.
The 8th Pay Commission will put higher salaries in the hands of over 3 crore government employees across central, state, PSU and local bodies.
Funding this without breaching the fiscal glide path will be a challenge and could lead to capital expenditure flattening over the next couple of years.
The hope is that Budget 2026 succeeds in defreezing gold and silver, maintaining fiscal discipline, and providing for the Pay Commission.
Along with existing measures that have already put money in the pockets of taxpayers, consumers, borrowers and speculators, this could support growth—especially if spending is directed towards swadeshi goods and services.
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Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of the expert, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.
