India’s market rally is just getting started: Emkay strategist on IT, smallcaps and sectors to buy

The Indian stock market may be entering the early stages of a broader rally, supported by a recovery in corporate earnings and the return of foreign portfolio inflows, according to Seshadri Sen, Head of Research and Strategist at Emkay Global Financial Services.

In an interview, Sen said the earnings downgrade cycle has largely ended, while the rebound in information technology stocks is only midway through a valuation-led rerating. For the next 12–18 months, he prefers consumption and industrial stocks, sees attractive opportunities in NBFCs and smaller private banks, and recommends a balanced market-cap allocation with a modest smallcap bias.

Edited excerpts from a chat:


Where do you think we are in the market cycle now? Is this resilience signalling a durable bottom, or is the index vulnerable to another leg of correction?
We believe the market is in the early stages of a broader rally. Recent resilience suggests a durable bottom is forming, supported by two key drivers: a broad-based earnings recovery across sectors and the return of FPI inflows (Rs 202bn in Jul-26), which should sustain market momentum. While bouts of short-term volatility are likely, the underlying fundamentals continue to favour further upside rather than a deeper correction.

IT has gone from one of the most hated trades until June to July’s best-performing sector, even as global chip stocks sell off. Is India being bought as an “anti-AI trade,” or is the IT rally largely short covering without sufficient earnings support?
We see the IT rally as primarily valuation driven. The pessimism around AI gutting the traditional IT services had become excessive, and that narrative is now unwinding. Short covering has contributed, but it is not the sole driver. The sector is in the middle of a rerating cycle, where valuations are catching up after being beaten down excessively, and we're likely only midway through it. That said, this is a sentiment and valuation recovery, not yet an earnings story—a genuine earnings recovery is still about 3-4 quarters away. So the move has legs from a re-rating standpoint, but the fundamental support will take a few more quarters to materialize.

Foreign investor sentiment towards India appears to be improving as the global AI trade comes under scrutiny. What would turn this tactical rotation into sustained FPI inflows—earnings upgrades, cheaper valuations, currency stability or lower oil prices?
The tactical rotation into India could evolve into sustained FPI inflows, but our base case is simply that FPI selling comes to an end. Any durable inflows beyond that would be icing on the cake. We're not banking on a flood of foreign money; rather, we expect the persistent selling pressure to ease first. Three factors would drive this shift: earnings momentum (as corporate profits recover and upgrades follow), currency stability (a steady rupee reduces FX risk for foreign investors), and weak oil prices (which ease India's import bill and support the macro picture). If these align, the tactical trade can evolve into steadier, more durable inflows over time.

The market is betting that the earnings slowdown has bottomed, but corporate performance remains highly divergent. Has the earnings downgrade cycle ended, and where do you believe consensus estimates are still too optimistic?
Yes, we believe the earnings downgrade cycle has largely ended, and a broad-based earnings recovery is now underway. The momentum looks stronger in midcaps and smallcaps, driven by two key forces: robust consumption momentum (as demand holds up across discretionary and staples) and a recovery in government capex spending (which flows through to infrastructure, capital goods, and allied sectors). These drivers should lift earnings more broadly as the cycle turns. Consensus expectations appear broadly reasonable, with the risk now skewed more toward upside than downside.

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Within financials, where is the best risk-reward now—large private banks, PSU banks, NBFCs, insurers or capital-market businesses? Which part of the sector is most vulnerable to an earnings disappointment?
Within financials, we see the best risk-reward in NBFCs, supported by improving credit growth, easing funding costs, and stronger earnings momentum. Large private banks remain relatively less attractive; despite a multi-year de-rating, large-cap bank valuations are still sitting above the fair-value zone. Instead, we prefer SMID private banks and capital-market plays. SMID private banks offer the clearest RoA-recovery story, backed by improving CASA and a turnaround in asset quality, while capital-market intermediaries benefit from the structural shift in household savings toward equities. We remain cautious on PSU banks, which face a tough FY27 as the collapse in treasury profits weighs on earnings.

Midcap and smallcap stocks have recovered sharply whenever risk appetite returns, but valuation concerns persist. Has the correction restored a sufficient margin of safety, or should investors continue rotating towards largecaps?
Mid- and small-caps continue to offer the highest return potential, but they also carry higher risk given richer valuations. Rather than making a wholesale shift to large-caps, investors should maintain a balanced allocation across market caps, with a modest bias toward small-caps where earnings growth remains stronger.

If you were constructing an Indian equity portfolio for the next 12–18 months, which sectors would you overweight and underweight?
We would overweight consumption and industrials, as they are well placed to benefit from a recovery in domestic demand and a pickup in government capex. We remain underweight financials, where earnings momentum is relatively weaker due to large weight in private banks and upside appears more limited compared with other sectors.