Daily Voice: US-India trade deal could be a catalyst for sustained market uptrend, says this fund manager

India enters Q2 FY26 with a favourable economic backdrop. Q1 GDP growth was robust at 7.8% YoY, driven by strong government spending and a resilient services sector. With headline CPI easing to 2.07% in August, inflationary pressures remain contained, benefiting consumption and corporate margins. In particular, the Manufacturing PMI (61.2) and Services PMI (60.1) indicate solid demand in industrials and services, further supported by core-sector growth of 6.3% in August.

Expectations from the earnings season point towards a moderate beat across sectors, particularly in domestic cyclicals like industrials, capital goods, and building materials. Capital goods, in particular, should benefit from sustained government capex, with FY26 capex outlay at Rs 11.11 lakh crore.

Retail demand, though impacted by GST adjustments, is expected to pick up towards the end of Q2, aided by favourable inflation trends and festival season dynamics. On the flip side, IT may continue facing pressure due to US policy risks, but operational resilience should still support a steady quarter.

Overall, while broader market indices may show modest growth, earnings breadth will likely outperform, particularly in cyclical and infra-linked sectors.

With regard to the IT sector, do you think Q2 is unlikely to deliver negative surprises compared to Q1?

The Q1 IT earnings season marked a slower pace than expected, but it was not as bleak as feared. For example, Infosys managed a 2.6% QoQ growth in revenue and raised its full-year revenue guidance. However, discretionary IT spending remains under pressure, with pricing and deal volume softer than in previous years. The H-1B fee hike and potential visa restrictions in the US pose additional risks for on-site labour cost escalation, making Q2 commentary crucial for investors.

Looking ahead, Q2 is expected to be steadier for the sector, given the sequential stability in large cap IT companies and fewer risks from wage inflation or capacity mismanagement. However, geopolitical risks and visa-related issues may introduce an element of caution in management commentary.

Q2 results are likely to be operationally in-line, with slower-than-expected revenue growth but better-than-feared margin performance, owing to improved automation and AI-driven productivity tools.

Which sectors do you expect to outperform in terms of earnings in Q2?

Three sectors stand out as likely outperformers in Q2 FY26:

Capital Goods & Industrials: With government-led capex continuing to drive demand, sectors such as cement, steel, and infrastructure construction are poised for growth. Core sector output growth, up 6.3% in August, provides further tailwinds. Companies in construction materials and building products should also see stronger-than-expected revenue growth driven by strong project execution and higher volumes.

Consumer Goods: The GST 2.0 tax cuts, along with benign inflation (2.07% CPI in August), should spur discretionary and non-discretionary demand, particularly in durables and automobiles. Though August saw a weak auto dispatch number, the festive demand cycle and improving retail sales point toward upside potential for Q2.

PSU Banks: Public sector banks should continue their outperformance relative to private banks, given the lower base of non-performing assets (NPAs) and higher credit demand from infrastructure-related projects. NPA ratios in PSBs have dropped to 2.6%, setting the stage for continued asset quality improvement and further earnings support.

Do you see the RBI’s Monetary Policy Committee (MPC) keeping the repo rate unchanged on October 1, despite benign inflation and strong Q1 GDP growth, as it waits for policy transmission before considering monetary easing?

Yes, the RBI’s Monetary Policy Committee (MPC) is expected to hold the repo rate unchanged at 5.50% on October 1, despite the benign inflation print and strong GDP growth in Q1 FY26. The inflation print for August, at 2.07%, remains well within the RBI’s target band. However, the MPC has maintained a data-dependent stance and will likely refrain from further cuts until the impact of previous easing measures is fully transmitted.

The Q1 GDP growth of 7.8% reflects healthy domestic demand, but the central bank will want to see continued transmission of past rate cuts into real-world credit and investment behaviour. The transmission lag is particularly evident in retail and small businesses, and the RBI may prefer to wait until Q3 FY26 for a clearer picture of policy impacts.

Thus, while inflation is benign and GDP growth is strong, the policy pause is necessary to allow monetary easing measures to take full effect before considering any further rate cuts.

Considering the current weakness and the fact that the Nifty has already retraced more than 50% of its recent rally, do you think the India-US trade deal is now a more significant factor than domestic triggers?

While domestic triggers such as infrastructure capex, GST reforms, and earnings growth remain supportive, external policy risks, especially the India-U.S. trade deal, have become more significant. The recent tariff announcements and H-1B fee hikes have raised concerns about the long-term impact on Indian IT exports and labour cost structures. This could overshadow domestic factors in the short term, especially as the Nifty has retraced more than 50% of its recent rally, suggesting that global policy uncertainties are weighing heavily on investor sentiment.

The August lows could be at risk if trade negotiations between India and the US remain stagnant or if tariff-related issues escalate further. A resolution of these issues, however, could fuel a strong recovery in the markets, with the U.S.-India trade deal potentially becoming a catalyst for sustained market uptrend. Until then, the domestic story remains supportive, but a robust rebound toward record highs will likely require a strong trade agreement to ease market concerns.

Do you expect PSU banks to continue outperforming private banks in the short term?

PSU banks are likely to continue outperforming private banks in the short term. The NPA ratio for PSU banks has improved to 2.6%, a multi-year low, and credit growth continues to be driven by infrastructure and capital-intensive sectors. The strong government capex push, alongside ongoing clean-up of legacy NPAs, gives PSU banks an edge in the short run. Their valuation relative to private banks is more attractive, given their improving asset quality and exposure to sectors benefiting from the government’s push.

Private banks, though still strong, may face margin pressures as rate cuts begin to squeeze net interest margins (NIMs). Additionally, their exposure to retail credit, while positive over the long term, may lead to short-term volatility if interest rate cuts slow demand for loans.

Overall, PSU banks offer superior tactical upside in the near term, supported by their stronger asset quality and government-linked growth, while private banks are likely to experience more volatile earnings performance as credit growth slows and cost pressures rise.

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