As markets normalise, SBI MF sees large caps maintaining leadership over mid- and small-caps in 2026

India’s underperformance relative to emerging market peers during 2025 also led to a moderation in its valuation premium. According to the outlook, this normalization improves India’s relative position within the emerging market universe, particularly as global investors reassess risk and valuations.

• Large-cap stocks expected to outperform mid- and small-caps in 2026
• Large caps led 2025 market gains; broader markets showed weak breadth.
• Domestic investors played a key role in stabilizing equity markets during 2025

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As Indian equity markets move into 2026, large-cap stocks are expected to be better placed amid lingering earnings uncertainty and uneven growth conditions. According to SBI Funds Management’s Market Outlook 2026, relative valuations continue to favor large-cap companies over mid- and small-cap stocks, while earnings visibility remains stronger among established firms with scale, liquidity, and robust balance sheets.

"In terms of relative valuations, broader markets stayed expensive versus large caps. Through the year this reflected in narrowing of market breadth with Nifty and Sensex delivering 12% and 10.5% returns for CY25 respectively but Nifty Midcap 150 index trailing at 6.2% and Nifty Smallcap 250 index declining 5.3%. Entering 2026, that relative picture hasn’t changed much, and we expect leadership to stay with large caps and therefore polarization to increase," the report said.

While the report does not rule out opportunities in the broader market, it cautions against indiscriminate exposure. Selective pockets within the mid- and small-cap segments may still offer value, but the emphasis for investors is expected to shift decisively toward quality and stock selection, rather than broad market momentum.

Normalization continues into 2026

The report notes that after several years of elevated valuations and euphoric investor sentiment, Indian equity markets underwent a sharp correction in the early part of last year, marking a turning point in market behaviour.

The report describes 2025 as a year of normalization of excesses. Equities entered the year with expensive valuations and heightened optimism, but the correction in January and February helped realign markets closer to fundamental realities. Frontline indices declined meaningfully, while mid- and small-cap stocks experienced deeper drawdowns, reflecting the unwinding of speculative excess that had built up over time.

As a result, investor sentiment cooled substantially, moving back to neutral levels from readings that had earlier indicated euphoria. This shift pointed to a healthier and more balanced market environment.

Valuations reset, asset allocation adjusts

The report notes that equity valuations, tracked as a spread over government bond yields, moved closer to long-term historical medians as both stock prices corrected and bond yields softened. This shift led to a reassessment of asset allocation strategies.

SBI Funds Management’s internal framework moved to a neutral stance on equities, with recommended equity allocation rising to around 60%, compared with 20% at the beginning of 2025. The change reflects improved valuation comfort, even as growth and earnings visibility remain uneven.

Headline gains mask weak market breadth

Despite the early-year volatility, benchmark indices ended 2025 with double-digit gains. However, the report cautions against focusing solely on headline index performance. Market outcomes during the year were highly uneven.

While large-cap indices delivered relatively strong returns, broader markets struggled. Mid- and small-cap stocks significantly underperformed, and weak market breadth emerged as a defining feature of the year. Gains were concentrated in a narrow set of large-cap stocks, reinforcing the degree of polarization within the market.

According to the outlook, this narrowing participation reflects a structural shift in market behaviour rather than a temporary anomaly. Leadership is increasingly concentrated in large-cap stocks, a trend the report expects to continue into 2026.

Policy support stabilizes, earnings recovery gradual

Government and central bank actions played a stabilizing role through 2025. Measures such as income tax cuts, GST rationalization, labor reforms, and aggressive monetary easing by the Reserve Bank of India helped cushion the slowdown and improve overall financial conditions.

However, the report notes that policy support alone is unlikely to translate into an immediate or broad-based earnings recovery. Corporate earnings growth remains subdued, although early signs of stabilization have begun to emerge.

The pace of earnings downgrades has slowed, with upgrades and downgrades now broadly balancing each other. This suggests that earnings expectations may be nearing a trough, even if a strong rebound is still some distance away.

Flows point to a structural shift

Foreign portfolio investors remained net sellers through much of 2025, but strong domestic institutional inflows provided an important counterbalance. The report points to this as evidence of a structural change in India’s equity markets, with domestic investors playing a growing role in absorbing volatility and supporting market stability.

India’s underperformance relative to emerging market peers during 2025 also led to a moderation in its valuation premium. According to the outlook, this normalization improves India’s relative position within the emerging market universe, particularly as global investors reassess risk and valuations.