Indian equity markets are navigating a volatile phase marked by persistent foreign institutional investor (FII) outflows, resilient domestic institutional investor (DII) inflows, and heightened geopolitical uncertainty stemming from the ongoing West Asia conflict. While benchmark indices have remained relatively range-bound in recent months, sharp swings in crude oil prices, concerns over inflation, and earnings downgrades across key consumption-linked sectors have kept investors' sentiment fragile.

Despite the turbulence, robust domestic liquidity and steady retail participation have prevented deeper market corrections, highlighting the growing role of local investors in supporting Indian equities.

In an interview with Fortune India, Gautam Duggad, Director & Head of Research, Institutional Equities, Motilal Oswal Financial Services, shared his outlook on market direction, the impact of geopolitical developments, the sustainability of domestic flows, and the triggers that could revive foreign investor interest. He also discussed the sectors and investment themes likely to outperform in the next phase of the market, along with his view on defensive versus cyclical opportunities.

How are you interpreting the recent volatility in Indian equities amid sustained FII outflows and strong DII inflows?

Duggad: The uncertain path to resolution in the West Asia war and its resultant impact on key global commodity prices have kept volatility in Indian equity markets at elevated levels, as markets have swung wildly with the changing contours of the war. Markets will have to endure a more volatile phase until there is a clear resolution.

Crude oil prices have stayed above $100 for a prolonged period and have driven earnings cuts in broader markets (especially in consuming sectors like autos, cement, durables, downstream O&G, fertilizers, etc.), thereby reversing the improving earnings momentum witnessed from 1QFY26 to 3QFY26. However, despite the ongoing conflict, DII flows have remained resilient and continue to be robust — again underscoring the altered approach of retail investors toward intermittent crisis situations. On the other hand, persistent FII selling has capped market upside and kept equities largely range-bound since Sep’24. DII inflows are expected to remain strong and focused on pockets with clear earnings visibility, whereas a turnaround in FII flows will depend on relative global valuations, easing geopolitical risks, and signs of saturation in the AI play.

Do you see the current market correction as valuation-led, liquidity-driven, or influenced more by global and geopolitical factors?

Duggad: Multiple factors have capped market momentum, with the correction largely driven by the escalation of the Israel/US–Iran conflict, the sharp rise in crude oil prices above $100, and resulting earnings downgrades. The Indian market remained resilient and near its highs following the announcement of a US trade deal in Feb’26, but corrected as these global risks intensified. Liquidity from foreign investors has also played a role, with FIIs withdrawing $20 billion since the start of the West Asia war. However, domestic liquidity has stayed strong and supportive.

What is your near-term outlook for Indian markets given persistent foreign selling and resilient domestic flows?

Duggad: The near-term outlook is dependent on developments in the West Asia war and the ongoing earnings season. While recent overtures between the US and Iran are encouraging signs toward a resolution, any sustained rise in crude prices above $100 per barrel could further impact earnings estimates as strategic reserves get depleted. The 4QFY26 earnings season has come in better than estimated, but investors’ focus is shifting more toward FY27 earnings now. A decisive de-escalation in the West Asia conflict will be the biggest trigger for a sustained upmove in Indian markets, as most other parameters are still looking better than they were six to twelve months ago.

Which recent macro or global factors are having the most impact on sentiment — rates, geopolitics, or earnings trends?

Duggad: Geopolitics and earnings trends have been the dominant drivers of sentiment over the past month, with the escalation in the West Asia conflict impacting risk appetite and triggering earnings downgrades amid elevated energy prices. This has been further exacerbated by relatively stretched global valuations, a weakening rupee, and limited participation in global AI-led themes. A higher-rate environment could become another source of concern if rates move further upward.

Are current DII inflows strong enough to fully offset FII volatility, or do they mainly provide downside support?

Duggad: DII inflows have been exceptionally strong, remaining net positive for 33 consecutive months and totaling $145 billion since Oct’24; however, they have not been sufficient to fully offset FII-driven volatility. Despite these robust inflows, markets have struggled to sustain peak levels and have witnessed intermittent drawdowns due to persistent FII outflows (approximately $52 billion over the same period). That said, DII flows have played a critical role in providing downside support. Even amid sustained FII selling, the market has remained relatively resilient, avoiding sharp corrections of more than 15% from peak levels.

What signals would indicate a meaningful return of sustained FII inflows into Indian equities?

Duggad: FII sentiment has remained subdued amid elevated geopolitical risks, relatively high valuations, currency weakness, and the limited relative attractiveness of India versus global AI-led opportunities. A sustained return of FII inflows would likely be driven by easing geopolitical tensions, stability in the INR, sustained moderation in crude oil prices, improved earnings visibility, and fatigue in the AI trade.

In this environment, would you describe the market as fundamentally strong but sentimentally weak, or is there a deeper earnings concern?

Duggad: The market remains fundamentally strong but sentimentally weak. India’s macro fundamentals are robust, and corporate balance sheets are the cleanest and most deleveraged they have been in decades. Even at a conservative growth rate of around 6%, India remains among the fastest-growing major economies. Valuations have also corrected from their CY24 highs, easing a key overhang.

However, rising geopolitical tensions and elevated commodity and energy prices have intensified inflation concerns, increased vulnerability to higher energy imports, and raised risks around the current account and supply chain disruptions. These factors are weighing on sentiment and tempering optimism around a sustained recovery in corporate earnings, thereby increasing the risk of earnings downgrades if cost pressures persist. That said, a swift de-escalation of geopolitical tensions and moderation in commodity prices could contain these risks, limit downside to earnings, and improve investor sentiment.

Which new investment themes are likely to gain traction this year — AI adoption, manufacturing/PLI-led growth, consumption revival, or capex cycle recovery?

Duggad: While we believe most of the themes mentioned above should perform well, we continue to follow a bottom-up approach across the board. Within this framework, we remain positive on manufacturing, industrials and capex, diversified financials, consumer discretionary, and new-age platform themes.

Which sectors do you currently see as key outperformers in the next phase of the market — financials, industrials, IT, or consumer discretionary?

Duggad: Our key overweight sectors are autos, PSU banks, diversified financials, manufacturing and industrials, consumer discretionary, and new-age platforms. In contrast, we are underweight on oil & gas, private banks, metals, consumer staples, IT, and commodities/utilities.

Are defensive sectors still attractive, or is the market shifting back toward cyclical and growth-led sectors?

Duggad: Traditional defensive sectors such as IT, FMCG, and utilities have underperformed over the past one to two years, failing to deliver meaningful growth or downside protection, and have witnessed significant valuation de-rating. While valuations now appear more attractive, the moderate growth outlook continues to limit their appeal, and one needs to have bottom-up conviction in these sectors. As a result, we remain cautious and prefer selective incremental allocation to these segments at this stage.

That said, we maintain a constructive view on select defensive pockets, particularly telecom and healthcare, where growth visibility and earnings resilience remain relatively stronger.