Capital Goods, Defence, Electronics Manufacturing and CDMO Sectors Lead Growth Expectations; Earnings Recovery and Global Stability Could Support Indian Equities
Indian small-cap stocks could deliver relatively strong performance over the next 12 months as improving corporate earnings provide support to valuations, according to Mayur Patel, President and Fund Manager for Listed Equity at 360 ONE Asset. Patel expects small-cap earnings to grow by around 30% in FY27, compared with growth in the mid-teens for large-cap companies.
His outlook comes amid continued volatility in Indian equity markets, rising crude oil prices, foreign investor outflows and uncertainty surrounding global interest rates. While these factors could create short-term pressure, Patel believes earnings growth, improving exports and a more favourable global environment could support a recovery in domestic equities.
The outlook also highlights a potential shift in market leadership, with selected small-cap and mid-cap companies benefiting from strong demand in capital goods, defence, electronics manufacturing services (EMS) and contract development and manufacturing organisations (CDMOs).
However, stronger earnings expectations do not guarantee stock-price gains. Investors will need to assess valuations, balance-sheet strength, business quality and the sustainability of projected growth before increasing exposure to smaller companies.
Why Small-Cap Stocks Could Perform Better Over the Next Year
Patel expects small-cap stocks to remain relatively well positioned over the coming year, arguing that their recent outperformance has been supported by earnings growth rather than valuation expansion alone.
According to his assessment, small-cap earnings could increase by approximately 30% in FY27, compared with mid-teen growth for large-cap companies. If these estimates are achieved, smaller companies could benefit from stronger profit growth and improving investor confidence.
Several sectors are expected to contribute to this expansion.
Capital goods: Companies supplying machinery, industrial equipment and infrastructure-related products could benefit from investment in manufacturing capacity, infrastructure and industrial development.
Defence: Businesses involved in defence manufacturing and related technologies may benefit from domestic procurement initiatives and a growing emphasis on local production.
Electronics manufacturing services: EMS companies could gain from expanding electronics production, supply-chain diversification and demand for domestically manufactured products.
Contract development and manufacturing organisations: CDMOs may benefit from outsourcing by pharmaceutical and biotechnology companies seeking specialised manufacturing capabilities.
These sectors have different business models and risk profiles, so earnings growth will not be uniform across the entire small-cap market.
Patel also noted that the Nifty Smallcap 250's price-to-book valuation was at a modest premium to its long-term median. This suggests that valuations were not excessively elevated relative to that historical measure, although the assessment does not establish that every small-cap stock is attractively priced.
Three Key Triggers That Could Drive the Stock Market Higher
Patel identified three important factors that could support Indian equities over the next 12 months: corporate earnings growth, stronger exports and relief from global macroeconomic pressures.
1. Strong Corporate Earnings
Corporate earnings remain one of the most important drivers of long-term stock-market performance.
Following strong earnings in the June quarter of FY27, Patel expects September-quarter earnings growth to exceed 20% year-on-year for the Nifty 50 benchmark.
If companies continue to deliver healthy revenue growth and maintain margins, earnings could provide support to share prices even if valuation multiples remain stable.
Investors will be particularly interested in management commentary on demand, input costs, operating margins and future business visibility.
However, the quality of earnings growth will matter as much as the headline numbers. Sustainable growth supported by operating cash flows is generally more reassuring than profit increases driven by one-off gains or temporary cost reductions.
2. Improving Export Performance
Export growth is another potential source of support for the Indian economy and equity markets.
Patel highlighted the reported 26% year-on-year increase in merchandise exports in August, while electronics exports nearly doubled.
Stronger exports can benefit manufacturers, suppliers and businesses integrated into global supply chains. They can also support employment, capacity utilisation and investment in production facilities.
If the trend continues, export-oriented businesses may experience stronger order books and improved revenue visibility.
Nevertheless, export performance remains sensitive to global demand, trade restrictions, tariffs, currency movements and geopolitical developments. A sustained improvement will depend on whether higher export growth translates into stronger profitability.
3. Relief From Global Economic and Geopolitical Risks
The third potential trigger is an improvement in global conditions.
Patel highlighted the importance of stabilising global bond yields, progress towards resolving the West Asia conflict and greater clarity regarding US tariffs.
Stable or declining global yields could improve investor appetite for emerging-market equities. Lower crude oil prices could also ease inflationary pressure and reduce risks to India's import bill and currency.
Greater clarity on US trade policy would help businesses plan exports, investment and supply-chain decisions.
If these developments coincide with strong Indian corporate earnings, they could improve market sentiment and potentially encourage foreign investors to return.
Nifty 50 Earnings Outlook: More Than 20% Growth Expected in Q2
Patel expects the combined net profit of Nifty 50 companies to grow by more than 20% year-on-year in the September quarter of FY27.
After a strong FY27, he anticipates earnings growth of approximately 14% in FY28.
The outlook suggests that earnings momentum could remain healthy, although the growth rate may moderate after the current financial year.
Among the sectors, automobiles are expected to be a major contributor to earnings growth.
Banks could benefit from relatively stable asset quality and stronger credit growth, while non-banking financial companies (NBFCs) may continue expanding their loan books.
Consumer discretionary businesses could experience steady growth, while industrials, telecommunications, metals and energy companies may also report healthy earnings.
On the other hand, oil marketing companies, consumer staples, large pharmaceutical companies and IT services could face relatively softer earnings conditions.
These sector-level expectations provide investors with a framework for examining quarterly results, but actual performance will depend on company-specific factors, demand conditions and cost pressures.
Automobiles, Banks and Industrials Among Sectors to Watch
The sector outlook indicates that India's domestic demand and investment cycle could play an important role in determining market performance.
Automobiles: Vehicle manufacturers and component suppliers could benefit from demand conditions, product launches, improved product mix and operating efficiencies. Investors should also monitor input costs, financing conditions and the pace of consumer spending.
Banking: Stronger credit growth and stable asset quality could support earnings. However, investors should examine deposit growth, funding costs, loan pricing and potential changes in bad-loan formation.
NBFCs: Continued expansion in lending could support revenue growth, but asset quality, borrowing costs and the ability to manage credit risk remain important considerations.
Industrials and capital goods: Companies benefiting from infrastructure spending, manufacturing investment and industrial expansion may experience stronger order inflows and revenue visibility.
Metals and energy: Earnings could be influenced by commodity prices, global demand and input costs. Higher crude oil prices may benefit some producers while creating margin pressure for companies that consume energy.
Investors should avoid assuming that an entire sector will perform uniformly. Within each industry, companies with stronger balance sheets, efficient operations and sustainable competitive advantages may be better positioned to withstand volatility.
Why Foreign Investors Have Stayed Away From Indian Equities
Despite India's domestic economic strengths, foreign institutional investors have remained cautious about increasing their exposure to Indian markets.
Patel attributed the reluctance partly to rising US bond yields, which have narrowed the yield differential between India and the United States to around 200 basis points.
Higher US yields can make American fixed-income assets more attractive relative to emerging-market investments, particularly when currency and market risks are taken into account.
Elevated crude oil prices, which have been trading around $100–$110 per barrel in the conditions described by Patel, have also created concerns about India's external balance and the rupee.
Another factor is the global flow of capital towards artificial intelligence-related investment opportunities in markets such as Taiwan and South Korea.
When investors concentrate capital in a particular global theme, other markets may experience reduced allocations even when their domestic economic outlook remains relatively favourable.
According to Patel, a sustained return of foreign investors would require three developments: stabilisation in global bond yields, progress towards resolving the West Asia conflict and greater clarity on US tariffs. Consistent corporate earnings growth could provide an additional incentive.
For Indian equities, the return of foreign capital could improve liquidity and sentiment, although domestic institutional investors and retail participation will remain important influences on market direction.
India's Relative Valuation Gap Has Narrowed
Patel also highlighted the change in India's relative valuation compared with other emerging markets.
According to his assessment, India's price-to-book premium over emerging markets has fallen to around 30%, compared with a peak of approximately 150%.
This reduction suggests that the valuation gap between India and competing markets has narrowed considerably.
For investors, relative valuations can influence capital allocation decisions. If India's earnings growth remains resilient while valuations become more competitive, the market could become more attractive to domestic and international investors.
However, relative valuation measures must be interpreted carefully. A lower premium does not automatically mean that the market is undervalued, as differences in profitability, sector composition, growth prospects and risk can justify valuation gaps.
Investors should also examine forward earnings, return on equity, cash-flow generation and debt levels rather than relying exclusively on price-to-book ratios.
Flexi-Cap Funds Attract Higher Inflows
Flexi-cap mutual funds recorded a notable increase in net inflows during September, with inflows rising by more than 30%, according to the report.
Patel attributed the increase primarily to lower redemptions, while gross inflows remained broadly steady.
The improvement in earnings expectations across small-cap and mid-cap companies, combined with resilient systematic investment plan contributions and higher lump-sum investments, may have supported investor participation.
Flexi-cap funds can invest across large-cap, mid-cap and small-cap stocks, allowing fund managers to adjust allocations according to market conditions and investment opportunities.
This flexibility can be useful when relative valuations and earnings prospects change across market-cap segments.
However, the flexibility of the category does not eliminate market risk. Returns depend on portfolio construction, stock selection, sector exposure and the fund manager's investment decisions.
Investors should evaluate a fund's strategy, costs, risk profile and performance across different market conditions before investing.
Multi-Asset Allocation Funds See Stable but Muted Inflows
While flexi-cap funds experienced stronger inflows, multi-asset allocation funds recorded more moderate growth, although monthly inflows stabilised at around ₹3,700 crore over the preceding three months.
The category's investor base continued to expand, with the number of folios increasing to more than 61 lakh from approximately 52 lakh in March. Assets under management also exceeded ₹2 lakh crore.
Patel suggested that the moderation in inflows reflected a cautious interest-rate outlook and investor preferences regarding the timing of investments.
Equity market corrections may also have encouraged some investors to direct money towards equity funds to take advantage of lower stock prices.
Multi-asset allocation funds invest across different asset classes, depending on their mandates. Their diversification can help manage certain portfolio risks, but performance depends on the allocation strategy and movements across the underlying markets.
Investors should understand a fund's asset-allocation approach and risk characteristics rather than assuming that diversification guarantees protection against losses.
Gold and Silver Outlook: Higher Interest Rates Remain a Headwind
Patel expects near-term pressure on gold to persist while US real yields and the dollar remain strong.
He noted that gold had corrected approximately 25% from its January peak to around $4,200 per ounce in the market conditions described in the interview.
Higher real interest rates can increase the opportunity cost of holding gold because the metal does not generate interest income. A stronger US dollar can also weigh on demand from international buyers.
However, Patel believes the medium-term investment case for gold remains relevant.
Central banks continue to purchase gold as part of reserve diversification, while geopolitical uncertainty and high global debt levels support the metal's role as a potential portfolio hedge.
Silver, meanwhile, is likely to remain more volatile because its price reflects both investment demand and industrial consumption.
For investors, this means gold and silver may respond differently to changes in interest rates, currency movements, economic growth and geopolitical risks. Their performance should not be assumed to move in the same direction or at the same pace.
Risks Investors Should Consider Before Buying Small-Cap Stocks
Although the earnings outlook for small-cap companies appears encouraging, investors should account for the risks associated with smaller businesses.
Higher volatility: Small-cap stocks can experience sharper price movements than large-cap companies, particularly during periods of market stress.
Liquidity risk: Some smaller stocks have limited trading volumes, which can make it difficult to buy or sell substantial quantities without affecting the market price.
Valuation risk: Strong earnings expectations may already be reflected in share prices. If companies fail to meet forecasts, valuations can contract quickly.
Corporate governance: Investors should assess the quality of management, transparency of financial disclosures, related-party transactions and capital-allocation decisions.
Debt and cash flow: Rapid growth does not necessarily translate into strong financial health. High borrowing costs, weak operating cash flows or excessive working-capital requirements can create problems.
Earnings sustainability: Investors should distinguish between businesses benefiting from long-term structural demand and those experiencing temporary improvements in orders or commodity prices.
A disciplined approach that focuses on company fundamentals and portfolio diversification may help investors manage these risks.
Market Outlook
The outlook for Indian equities over the next 12 months will depend heavily on earnings delivery, global interest rates, crude oil prices and the direction of foreign investment flows.
Mayur Patel's expectation of approximately 30% FY27 earnings growth for small-cap companies suggests that selected smaller businesses could offer attractive opportunities if they deliver on forecasts. Capital goods, defence, electronics manufacturing services and CDMOs are among the sectors highlighted for their growth potential.
For the broader market, expected Nifty 50 profit growth of more than 20% in Q2FY27 could provide support to sentiment, while the projected moderation to around 14% earnings growth in FY28 will make the sustainability of corporate performance increasingly important.
A stabilisation in global bond yields, easing geopolitical tensions and clarity on US tariffs could help improve foreign investor sentiment. Conversely, persistently high crude prices, elevated interest rates and disappointing earnings could prolong market volatility.