Why 2026 will be an earnings-driven market, not a broad rally: Axis MF’s Hitesh Zaveri explains

As Indian equity markets hover near record highs, investors are struggling to separate real investment opportunities from high-risk bets amid rising volatility. In this interaction with Business Today, Hitesh Zaveri, SVP & Head of Listed Equity Alternatives at Axis Mutual Fund, shares his perspective on market valuations, foreign investor flows, interest rates, and currency moves. He also outlines core sectors for long-term investors, key risks in mid- and small-cap stocks, IPO caution, and the structural themes that could shape India’s equity markets over the coming years. Edited excerpts:

Q). How do you assess current valuations in Indian equities, particularly in mid- and small-cap stocks, at a time when Indian and global markets are near record highs?

Hitesh Zaveri: Indian equity valuations today tell a story of divergence rather than excess. While headline indices like the Nifty are trading near record highs and still look somewhat expensive compared to their own history and bond yields, this does not mean all parts of the market are overheated. Beneath the surface, valuations metrics for many stocks appear to have corrected meaningfully. The “typical” stock in the market is now priced only slightly above its long‑term average, suggesting that a good portion of earlier froth has already been corrected. However, a good number of mid‑ and small‑cap stocks continue to trade at richer premiums, supported by optimistic earnings assumptions, leaving them more exposed if growth falls short.

Going ahead, markets may still have room to grow, but returns are likely to be more gradual and driven by earnings rather than valuation expansion, making selective stock‑picking—especially in large caps—far more important than riding the index. Actual outcomes will depend on how earnings and macroeconomic conditions evolve.

Q). Foreign investor flows have been volatile. Which global factors are you tracking that could influence FPI inflows over the next few months?

Zaveri: Foreign investor flows into India are likely to stay sensitive to any global developments in the near term. The most important factor to watch is the direction of US interest rates and bond yields—any easing there typically improves appetite for emerging markets like India.

Currency movements also matter. A strong or volatile dollar, or sudden moves linked to the yen carry trade, can prompt foreign investors to pull back from risk assets globally. In addition, investors are watching how the global AI‑driven rally evolves and whether India benefits from trade deals with the US or the EU, both of which could help restore confidence and attract fresh foreign inflows.

Q). For new investors, which themes or sectors should be considered as core long-term holdings?

Zaveri: For new investors building long‑term portfolios, the focus should be on stable, well‑established themes rather than short‑term market momentum. Most research points toward large, high‑quality companies with predictable earnings and strong balance sheets as the right starting point.

At the sector level, financials—especially large private and PSU banks— tend to stand out as core holdings, supported by steady credit growth and improving profitability. Consumption‑linked businesses, particularly those catering to urban and aspirational spending, may also offer durable long‑term opportunities. Investors may additionally look at infrastructure and capital‑spending themes, which may benefit directly from policy support and a multi‑year domestic capex cycle.

Technology services and utilities, especially companies tied to digital transformation and the energy transition, add diversification and resilience over time. Overall, the emphasis should be on owning a few strong sectors for the long run, while using market corrections—and not market highs—as opportunities to gradually build exposure rather than chase shorter‑term trends.

Q). How might changes in interest rates both in India and globally impact equity markets in the coming months?

Zaveri: Interest‑rate movements will remain a key driver for equity markets in the coming months. In India, further rate cuts by the RBI, if they materialise, would be supportive for equities, especially banks, real estate, and other rate‑sensitive sectors, by improving affordability and boosting demand.

That said, markets are unlikely to see a sharp valuation re‑rating purely on lower rates, as equity valuations are already high relative to bond yields. Globally, the path of US interest rates and bond yields is equally important—any delay in global easing or renewed rise in yields could weigh on foreign flows and market sentiment, keeping equity gains more earnings‑driven and selective rather than broad‑based.

Q). Rupee depreciation is often seen as both a risk and an opportunity. How are you factoring its impact into your sector and stock choices?

Zaveri: A weaker rupee is neither an outright positive nor a pure risk—it creates winners and losers across sectors. From an earnings perspective, mild depreciation is helpful for export‑oriented sectors such as IT services, pharmaceuticals and select manufacturing, as dollar revenues translate into higher rupee earnings.

That said, sharp or volatile currency moves can hurt overall market sentiment by raising input costs, pressuring inflation, and unsettling foreign investors. This is why our focus remains on companies with pricing power, domestic demand visibility, and strong balance sheets, which can absorb currency swings. Overall, we see a stable‑to‑gradually weaker rupee as manageable and are positioning for selective opportunities rather than making broad sector bets purely on currency moves.

Q). What other key risks should retail investors watch out for in 2026, especially in mid- and small-cap stocks amid global uncertainty?

Zaveri: For retail investors, the biggest risk in 2026 is assuming that the broader market’s stability automatically extends to mid‑ and small‑cap stocks. While headline indices may remain resilient, many smaller companies are still priced for strong earnings growth, leaving little room for disappointment if demand, margins, or execution fall short.

Another key risk is liquidity. Mid‑ and small‑caps are more dependent on steady domestic inflows, and any slowdown in retail participation or mutual fund investments could lead to sharper price corrections. At the same time, a busy calendar of IPOs, block deals and fund‑raising may divert liquidity away from the secondary market, putting further pressure on these stocks.

Global uncertainties also matter. Sudden swings in US interest rates, the dollar or geopolitics can quickly alter foreign investor sentiment, and such episodes usually hurt riskier parts of the market first. Against this backdrop, retail investors should focus on balance‑sheet strength, earnings visibility, and valuation discipline, and avoid chasing momentum in less proven businesses—even if overall markets appear calm.

Q). Are there any sectors currently out of favour that could offer attractive opportunities if they stage a recovery?

Zaveri: Yes, several sectors that have been out of favour over the past year could potentially offer attractive opportunities if the recovery plays out as expected, although this naturally depends on how broader conditions evolve. IT services may stand out after a prolonged slowdown, where earnings downgrades and valuation corrections have already occurred; any improvement in global demand or stabilisation in US interest rates could possibly help the sector stage a gradual comeback, though the timing and extent may vary.

Rate‑sensitive sectors such as real estate and select NBFCs also merit attention. These areas have lagged amid cautious demand and higher funding costs but could benefit meaningfully if interest rates ease further and domestic growth remains stable. In addition, cement and capital‑spending linked industries—which struggled during the earnings downgrade cycle—could see improving profitability as demand revives and cost pressures ease, provided supportive trends continue.

That said, these opportunities are likely to be selective rather than broad‑based. Investors should focus on companies with strong balance sheets, pricing power, and earnings visibility, as recoveries in out‑of‑favour sectors tend to reward quality first rather than the weakest names.

Q). With a strong pipeline of IPOs, what should investors keep in mind when choosing between new listings in the current market environment?

Zaveri: With a strong IPO pipeline, investors need to be more selective than enthusiastic. In the current market, many new listings are coming at full or even aggressive valuations, leaving limited scope for quick gains if earnings delivery falls short.

Retail investors should focus less on listing‑day performance and more on the quality of the business. Clear revenue visibility: sensible capital allocation and realistic growth assumptions matter far more than market buzz. It is also important to watch who is selling and why: IPOs dominated by promoter or private‑equity exits typically carry higher risk than those raising capital primarily for growth.

Finally, in a market where liquidity is finite, heavy IPO issuance can divert flows away from listed stocks, increasing volatility in the secondary market. As a result, investors should treat IPOs as long‑term equity decisions, stagger their participation, and avoid chasing oversubscription or narrative‑driven stories that are not supported by fundamentals.

Q). Beyond traditional sectors such as consumption and banking, which long-term themes do you believe will shape India’s equity market over the next decade?

Zaveri: Beyond traditional sectors like banking and consumption, several structural themes are likely to shape India’s equity market over the next decade. One key theme is domestic capital expenditure, spanning infrastructure, defence, power, and manufacturing. As India continues to invest in roads, railways, energy transition and strategic manufacturing, companies linked to capital goods and engineering could potentially stand to benefit from a sustained multi‑year cycle rather than a short burst of growth.

Another long‑term driver is technology‑enabled transformation, not just in IT services but across industries—from digital payments and financialisation to data centres and enterprise digitisation. Closely linked is the energy transition, including renewables, power utilities, and grid infrastructure, which is often viewed as offering steady, regulated and cash‑flow‑oriented opportunities over time.

Finally, formalisation and financial deepening remain powerful under‑the‑surface trends. As more economic activity moves into the organised sector, businesses in logistics, capital markets, insurance, and asset management are likely to compound steadily. Together, these themes point to an equity market that will increasingly reward scale, execution, and long‑term visibility, making patient ownership of strong franchises more important than chasing cyclical winners.

Q). The Sensex, Midcap, and Smallcap, indices across the categories have delivered muted returns over the past year. What is your outlook for the year 2026?

Zaveri: After a year of muted returns across large‑, mid‑ and small‑cap indices, 2026 looks more like a year of selective recovery than a broad market rally. Index returns are likely to be moderate and earnings‑driven, as valuations leave limited room for sharp re‑rating, especially at the headline level.

Within this, large caps appear better positioned due to stronger balance sheets, improving earnings visibility and more reasonable risk‑reward after recent underperformance. Financials, select consumption names, IT and rate‑sensitive sectors may stand out as relative outperformers if growth and policy transmission play out as expected.

Mid‑ and small‑caps may also participate, but likely later in the cycle and in a more selective manner. Given elevated expectations and tighter liquidity, leadership in 2026 is expected to be narrower, rewarding quality businesses and disciplined stock selection rather than broad exposure to the entire market.