Stock market strategy: Cautious optimism amid valuation froth, Israel-Iran war; Small-caps, mid-caps still overheated

Mint

4 hours ago

Indian stock markets have witnessed a strong rally since April, driven by macro tailwinds and investor optimism. However, experts now advise a more measured approach going forward, citing stretched valuations, geopolitical uncertainty, and sector-specific vulnerabilities.
Seshadri Sen, Head of Research and Strategist at Emkay Global Financial Services, believes that after around a 10% surge in the Nifty 50 since April 9 — when tariff pause news lifted sentiment — the markets are likely to 'pause for breath.'
He noted that the valuation comfort has largely dissipated, and the ongoing Middle East conflict due to the Israel-Iran war could act as a trigger for a short-term correction.
The Israel-Iran conflict has added a new layer of uncertainty. According to Sen, the most immediate risk for India lies in the spike in crude oil prices, which could impact the current account deficit, fiscal position, and inflation. That said, he believes this shock is likely to be temporary. Structural factors such as the global energy transition and slowing Western economies suggest crude fundamentals remain weak.
Foreign portfolio flows may also be volatile in the near term. However, Emkay Global remains confident in India's long-term story. 'Our fundamental thesis on Indian markets is unchanged as of now,' says Sen, although the brokerage will reassess its view if crude remains elevated over the next 2-3 months.
On the earnings front, Emkay sees encouraging signs. FY26 Nifty EPS estimates have been stable, and the breadth of downgrades has narrowed significantly. The brokerage expects earnings to recover, driven by aggressive rate cuts from the Reserve Bank of India (RBI) and continued commodity softness, which will support margins.
'We believe we are at the bottom of the earnings downgrade cycle and see a possibility of upgrades,' Sen said. Emkay maintains its FY26 and FY27 Nifty EPS estimates at ₹ 1,128 and ₹ 1,294, respectively.
From a valuation standpoint, Emkay Global and InCred Equities highlight concerns. The Nifty 50 is trading at 20.9x one-year forward P/E — slightly below the long-term average — but small- and mid-cap (SMID) stocks appear overheated. Emkay notes that 38% of BSE200 stocks now trade above their 5-year average valuation, up sharply from just 12% in April.
Still, SMID stocks remain a favored area due to their stronger growth profiles and improving balance sheets. Investors, however, are advised to be selective, particularly when valuations exceed historical averages.
InCred Equities has raised its bull-case probability for the market to 35% (from 25%) amid improving macro signals like above-normal monsoon prospects, expected repo rate cuts, and easing oil prices. As a result, it has marginally raised its Nifty target for March 2026 to 25,142 from 24,280 earlier.
However, the brokerage warns that the recent broad-based rally has priced in much of the macro optimism, leaving limited short-term upside. Consequently, InCred is turning selective in its stock picks, booking profits in names like Adani Ports & SEZ and Cipla, and initiating coverage on mid-sized banks that benefit from improving liquidity conditions.
Both brokerages agree on a more selective and sector-specific approach. Emkay favors Discretionary, Technology, and Materials, while remaining underweight on Financials and Staples. InCred is bullish on mid-sized banks and remains cautious on segments with inflated valuations.
The near-term market strategy hinges on managing geopolitical risk, monitoring crude trends, and maintaining earnings discipline — all while navigating a landscape of stretched valuations with careful stock selection.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.