By Motilal OswalAs we enter FY27, Indian equity markets are balancing strong domestic fundamentals against an uncertain global backdrop. While policy support, improving growth, and resilient domestic flows provide a solid foundation, geopolitical risks—particularly the ongoing Iran–Israel/US conflict—continue to weigh on near-term sentiment.The domestic macro environment remains supportive. India is coming off a favorable base, aided by fiscal and monetary easing, progress on trade agreements, and better-than-expected GDP outcomes. Demand conditions are gradually improving, and retail participation in equities continues to deepen. However, the escalation in West Asia has emerged as a key near-term risk, especially given India’s dependence on energy imports, with ~35–40% of crude demand and ~54% of pre-war LPG flows routed through the Strait of Hormuz.FY26 was largely shaped by global factors rather than domestic weakness. A series of events—from the US “Liberation Day” tariff announcement in April 2025 to the escalation of geopolitical tensions towards the end of the year—kept volatility elevated. The Nifty 50 declined ~5%, marking its weakest performance in six years. Midcaps showed relative resilience, with the Nifty Midcap-100 up 2.1%, while the Nifty Smallcap-100 declined ~6%.India’s underperformance was more pronounced in global terms. After a prolonged phase of outperformance, India emerged as the worst-performing major market in FY26, falling 14% in USD terms versus a 27% rise in MSCI EM and 16% in the S&P 500. This divergence came despite improving earnings trends and reflects a shift in global capital allocation.Three factors drove this trend. First, global uncertainties dominated investor sentiment, pushing risk aversion higher. Second, India’s limited participation in the global AI investment cycle diverted flows to other markets. Third, and most significantly, was the scale of FII selling. Outflows reached a record ₹3.3 lakh crore in FY26, including ₹1.2 lakh crore in March 2026 alone.In contrast, domestic flows provided a strong counterbalance. DIIs invested a record ₹8.5 lakh crore during the year, supported by SIP inflows exceeding ₹32,000 crore per month. Equity mutual fund AUM rose to ~₹39 lakh crore, with inflows sustained for 61 consecutive months. This structural shift towards domestic participation continues to anchor the market during periods of global volatility.The Iran–Israel/US conflict remains the most critical near-term variable. With over 85% of crude requirements imported, any disruption in the Strait of Hormuz poses risks through higher inflation, currency pressure, and margin compression. India has responded by diversifying supply—Russian crude imports rose ~90% in March 2026, and limited Iranian supplies have resumed after a seven-year gap. However, the duration and intensity of the conflict remain uncertain.At the same time, India’s balanced geopolitical approach has helped mitigate risks. Strong relationships across key global blocs have enabled continued access to energy and trade routes, positioning India relatively well in a fragmented global environment.The macroeconomic response from both the RBI and the central government has been substantial through FY26, even if markets have not yet fully priced it in. The RBI delivered cumulative repo rate cuts of 100 basis points, along with CRR reductions and liquidity measures. On the fiscal side, reforms such as personal income tax relief, GST rationalization, and progress on trade agreements with the UK, EU, and US are expected to support consumption and investment. While the market has yet to fully price in these measures, their impact should become more visible over FY27.The RBI’s April 2026 policy underscores a calibrated stance, with rates held at 5.25%. Growth for FY26 has been revised up to 7.6%, with FY27 projected at 6.9%. Inflation, currently at 1.95% for 11MFY26, is expected to rise to 4.6% in FY27, driven by higher crude prices and currency pressures. Assumptions have also been revised, with crude at USD 85/bbl and the exchange rate at INR 94/USD.Despite the index-level correction, India’s macroeconomic fundamentals have remained more resilient than the price action might suggest, and this resilience — combined with the extent of the valuation reset — is an important consideration for medium-term investors. Following the approximately 10% decline since the onset of the Iran-Israel/US conflict, the Nifty 50 is now trading at a 12-month forward P/E of 17.7x, a 15% discount to its long-period average of 20.9x. More significantly, India’s valuation premium versus MSCI EM, which had long been a point of friction for global allocators, has compressed sharply from a 10-year average of 73% to just 27% — approaching a multi-decadal low of 21%. Broader market valuations require more nuance: the Nifty Midcap-100 trades at 24.6x forward P/E, a modest 4% premium to its long-period average, while the Nifty Smallcap-100 is at 19.8x, a 15% premium to its historical average. The most attractive valuation case is therefore concentrated in large-cap equities, where the absolute discount and the narrowing EM premium together present a meaningful entry point for investors with a 12–18 months view.Earnings remain the key medium-term driver. We estimate a 16% CAGR in earnings for both the Nifty 50 and the MOFSL universe over FY26–28. Nifty EPS is expected to grow from ₹1,060 in FY26 to ₹1,246 in FY27 and ₹1,440 in FY28, implying growth of 18% and 16%, respectively. The policy tailwinds from rate cuts, GST simplification, and improved trade agreements — none of which are yet fully reflected in reported earnings — are expected to progressively support corporate profitability from FY27 onwards as domestic demand conditions improve.The near-term outlook for Indian equities is one of gradual, phased recovery, with the pace and sustainability of that recovery tied closely to developments in the West Asia conflict. A resolution — even a durable ceasefire — would improve the risk-reward calculus through multiple channels simultaneously: lower crude prices, rupee stabilization, a reduction in near-term earnings downgrade risk, and the potential for a meaningful reversal in FII flows. Any reversal of FII flow against the backdrop of the current valuation setup —— could result in a sharp re-rating over a relatively short timeframe.After witnessing sharp underperformance in CY25, Indian markets still declined with similar intensity to other EM peers post the start of the war. This suggests that despite the lower absolute and relative valuation, the Indian market is still not a top-down market, and portfolios should be designed on a bottom-up basis with growth visibility. Given the current valuation level, where we see limited downside, the upmove will be driven by earnings growth. Consequently, we recommend investing in companies with high earnings growth visibility that have experienced reasonable valuation contraction. Within this framework, we remain constructive on a few key themes. The sectors best positioned for the year ahead are financials, where credit quality and return ratios have both improved materially; consumption, where rural demand recovery and two good agricultural years create tailwind; and capital goods and infrastructure, where the government capex cycle remains structurally unbroken. IT warrants selectivity given US headwinds. Power and energy transition plays — driven by AI infrastructure and electrification demand — are the emerging structural theme of the decade.The structural case for India remains intact. Growth is steady, policy support is strong, and domestic flows provide stability. What has changed is valuation—markets are now at more reasonable levels.The key risk remains a prolonged geopolitical conflict. An extended disruption could keep crude prices elevated, pressure inflation and the currency, and weigh on corporate profitability.History offers perspective. The COVID-led 38% decline was recovered in six months, and past corrections have consistently rewarded investors who stayed invested rather than waited for certainty.The current disruption is cyclical and geopolitical. India’s structural drivers—rising incomes, financialisation (still ~5% of household wealth versus 40–50% in developed markets), manufacturing-led formalisation, and a young workforce—remain firmly in place.For long-term investors, this is not a setback, but an opportunity to stay invested and participate in the next phase of growth.(Motilal Oswal is the Group CEO and Co-founder of Motilal Oswal Financial Services)