Why equity outlook remains constructive while fixed-income returns may moderate

Global growth faces continued headwinds from trade frictions, policy uncertainty, and weak consumer sentiment. The IMF’s April 2025 World Economic Outlook downgraded global growth to 2.8 percent for 2025 and 3.0 percent for 2026, citing rising trade tensions. Advanced economies like the US saw sharp forecast cuts, while emerging Asia remains tariff-impacted.

Also read | The myths and realities of being an Accredited Investor

Inflation progress is mixed—headline inflation is nearing targets in Advanced economies (AEs), but core inflation lingers due to services. Emerging market economies (EMEs) are showing easing trends. Commodity markets remain volatile due to geopolitical and climate risks. Crude oil and metal prices are forecasted to fall in 2025–26, adding to global economic uncertainty.

US markets

In May, Moody’s downgraded the US sovereign credit rating from Aaa to Aa1, citing rising debt and interest burdens, marking the last of the major agencies to do so. This reflects broader concerns over US fiscal sustainability, inflation, and global competitiveness.

The downgrade coincides with a pivotal moment for the US economy — amid persistent inflation, trade uncertainty, and rising Treasury yields. Despite this, the S&P 500 rose 6.3 percent in May, led by tech and strong Q1 earnings, with 12.4 percent year-on-year growth. The “Magnificent 7” stocks significantly outperformed.

However, Q1 GDP printed -0.3 percent due to pre-tariff imports, while Q2 is forecasted at 4.6 percent. Trade deal uncertainty continues to cloud outlooks. With heightened valuation risks and geopolitical tensions, investors may become less tolerant of stretched multiples. This environment strengthens the case for diversifying into stable developed markets and selectively into emerging economies like India, especially as the US “exceptionalism” premium faces renewed scrutiny.

India overview

The Monetary Policy Committee (MPC) lowered the repo rate by 50 basis points to 5.5 percent to bolster growth and maintain inflation near the 4 percent target range. Corresponding adjustments were made to the SDF, MSF, and bank rate. Headline CPI inflation dropped to 3.2 percent in April, primarily due to easing food prices, with FY26 inflation forecasted at 3.7 percent.

Also read | Home loan dilemma: Should you prepay or invest after repo rate cut?

Favourable Rabi harvests, an expected above-normal monsoon, and steady food supplies strengthen the inflation outlook. To infuse durable liquidity, the CRR will be cut by 100 bps in four phases, releasing Rs 2.5 lakh crore by December 2025. Real GDP growth for FY26 is estimated at 6.5 percent, driven by strong rural consumption, expanding services, rising investment, and steady private demand.

Liquidity has turned into surplus since March. India’s macro fundamentals remain robust, supported by healthy sectoral balance sheets and the 3Ds—demography, digitalisation, and domestic demand. However, geopolitical tensions, trade disruptions, and climate risks continue to pose challenges.

Over the last 12 months, Indian equity markets have largely traded within a range when short-term fluctuations are excluded. The Nifty 50 hovered around 22,400 in May 2024, climbed to approximately 26,300 in September, fell to nearly 22,000 in March 2025, and has since rebounded to the 25,000 mark.

The recent rally from March has been driven more by price expansion than earnings growth, resulting in elevated P/E multiples across large-, mid-, and small-cap segments—also high when compared to developed and emerging markets. While these valuations warrant some caution, India’s strong macroeconomic fundamentals make it an increasingly compelling destination for global investors.

Also read | Gold is climbing again. Is it time to take some profits or stay invested?

In this phase of global uncertainty, the Indian economy reflects strength, stability, and opportunity. The strength arises from robust balance sheets across five sectors—corporates, banks, households, the government, and the external sector. Stability is observed across the price, financial, and political fronts. Opportunity is driven by the 3Ds—demography, digitalisation, and domestic demand. This 5x3x3 matrix continues to cushion the Indian economy against global spillovers and propel growth.

India is among the few large economies projected to grow at 6–6.5 percent over the next few years, supported by manufacturing, infrastructure buildouts, tax reforms, and a growing middle class. Falling WTI crude oil—from USD 78 to USD 66—has further improved India’s import bill, narrowed the trade deficit, and reduced pressure on the rupee, positively impacting inflation and fiscal stability.

While India remains a domestically driven economy, geopolitical tensions can impact commodity prices and trade. Yet, India’s strong external balances, lower export base, and geopolitical neutrality provide a solid economic moat.

Also read | Silver ETF AUM doubles in a year, outpaces gold ETFs despite lower returns

We maintain a constructive view on equities, driven by four key factors: robust consensus earnings (12 percent+ CAGR for FY26–27), supportive Union Budget, the RBI’s dovish stance, and favourable crude dynamics. We prefer accumulation in large- and mid-caps while staying selective in small-caps. Structural themes, localisation, and sectors like IT, Pharma, and Chemicals may offer attractive opportunities during corrections.

On the debt side, post the Monetary policy outcome (June 2025), it is important for investors to expect lower fixed-income returns going ahead as yields have rallied a lot over the last 1 year and large part of the rate cut cycle is behind us. We re-iterate to reduce duration of the bond portfolio and consider adding hybrid products offered by mutual funds over pure fixed-income play to take advantage of tax benefits offered by such products. Investors are advised to consider their risk profile and appetite before considering such hybrid products.

The writer is the founder of StatLane

Disclaimer: The views expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.