'Capital is flowing back to the US'

'Even if India is attractive, FPIs currently lack the funds to invest, as money is being redirected to the US.'

Kotak Institutional Equities is of the view that the markets are likely to remain range bound this year, as they continue to trade above historical averages and at a significant premium to the MSCI Emerging Markets (EM) index. 

Pratik Gupta, CEO and co-head of institutional equity at Kotak Securities, noted that the Nifty is currently trading at a price-to-earnings (PE) multiple of 19 times based on March 2026 earnings estimates.

This valuation appears elevated, considering earnings are expected to compound at 14 per cent in FY26 and FY27, with potential downside risks to these estimates.

"Given this, we do not foresee a meaningful upside for the Nifty in the short term," said Gupta, who shared insights from Kotak's recent investor conference.

However, the downside for the Nifty is cushioned by India's robust medium-term growth prospects, which are expected to sustain elevated valuations.

Additionally, a more favourable foreign and domestic liquidity environment in the second half of 2026 could provide further support.

Kotak Institutional Equities remains cautious about the outlook for small and midcap stocks, as their valuations have not moderated significantly despite recent market corrections.

The brokerage highlighted key downside risks for the broader market, including a sharper-than-expected global slowdown, a deficient monsoon, or a sharp decline in retail inflows into domestic equities -- particularly small and midcap funds.

On the upside, potential catalysts include a weaker US dollar, which could drive flows into EM funds, and a faster-than-expected private capital expenditure (capex) upcycle.

Based on feedback from foreign portfolio investors (FPIs), Gupta said Indian equity markets appear somewhat expensive.

Nevertheless, from a three-to-five year perspective, most foreign investors remain optimistic about India's medium-term growth outlook.

FPIs are looking to increase their exposure to Indian stocks once valuations become more attractive.

However, many EM funds are currently facing redemptions.

"Capital is flowing back to the US, partly due to a strong dollar and Trump's policies. Even if India is attractive, FPIs currently lack the funds to invest, as money is being redirected to the US," Gupta said.

He also pointed out that the capital gains tax has further dampened the appeal of Indian equities for FPIs.

"Over the past two years, most FPIs achieved around 20 per cent returns in rupee terms, with the rupee remaining relatively stable. After accounting for a 10 per cent long-term capital gains tax (for holdings over a year), returns were still attractive compared to US bond yields.

"However, with bond yields rising, return expectations from India declining, the rupee depreciating by 3-4 per cent, and higher capital gains taxes, FPIs are now left with 6.5-7.5 per cent dollar returns after deductions, taxes, surcharges, and fund manager fees. This is relatively low for an emerging market like India," Gupta added.

On the domestic front, Gupta noted that while equity inflows into local mutual funds, insurance, and portfolio management services (PMS) have slowed, overall net inflows remain positive.

"However, the nature of these flows has shifted. Previously, investments were directed towards small and midcap or thematic funds. But now, they are increasingly favouring largecap or balanced debt-equity funds," he said.

In terms of sectoral preferences, Kotak Institutional Equities continues to favour large private banks, non-banking financial companies (NBFCs), life insurance firms, residential real estate, hotels, and the airlines/hospitality sectors.

Conversely, the brokerage remains cautious on consumer staples, discretionary stocks, and the oil & gas and chemicals sectors.