India's equity markets are set for a leadership change with large-cap companies predicted to outperform over the next few quarters, according to Equirus Securities' latest India Equity Strategy report. The brokerage notes that domestic demand-driven sectors, particularly those linked to rural consumption, will continue to be at the forefront of growth, even as global uncertainties impact valuations.

Recent trends indicate a clear turnaround in rural consumption. Rural wages, after years of stagnation or contraction, have been rising steadily since the late 2024, with the period between February and May 2025 showing the strongest year-on-year gains since 2018 (overall rural wages +3.5% in May 2025). This wage growth directly boosts rural disposable income," the report states.

It emphasises that although India’s long-term structural drivers stay strong, investors should remain cautious about near-term risks.

“Indian equity markets are entering FY26 with cyclical headwinds but strong structural drivers. We are overweight on auto, capital market, cement, FMCG, infrastructure, internet platforms, NBFC, and oil & gas sectors. At the same time, we are underweight on building materials, industrials & defence, real estate, textiles, and logistics sectors,” said Maulik Patel, head of research, Equirus Securities.

One of the primary concerns in the report is overheated valuations in the small-cap sector. The report highlights that the small-cap forward P/E ratio is at 1.25x, just below the historic peak of 1.3x, compared to a long-term average of 0.88x.

“Large-caps provide the best margin of safety, mid-caps should be approached selectively in structural growth areas, and small-caps warrant caution until earnings catch up,” said Patel.

This shift suggests that investors are more likely to favour large, well-capitalised firms with stable earnings outlooks, especially as CY25 EPS forecasts have already been cut by 13.8%, the steepest decline since the pandemic.

Monetary easing provides additional support. The report also highlights the Reserve Bank of India’s gradual rate-cut cycle, which has been driven by CPI inflation dropping below 4% and liquidity moving into surplus.

“Historically, such easing results in muted short-term returns but yields stronger 12-month gains when macro conditions are favourable, favouring a barbell approach between cyclicals (financials, industrials) and defensives (consumer staples, healthcare),” the report notes.

Furthermore, government infrastructure spending remains at record highs, but the report suggests that FY26 may experience a pause due to tariff wars and global trade uncertainty. Even so, the long-term capital expenditure story remains strong, supported by state-led projects, Production Linked Incentive (PLI) schemes, and healthier corporate balance sheets.

The strategy note also highlights that domestic institutional investors are playing a larger role than foreign institutional investors in providing stability to the markets. With SIP inflows growing at a 27% CAGR between FY17 and FY25, domestic inflows now absorb much of the selling pressure from FIIs.

“Higher domestic participation absorbs FII selling and reduces market sensitivity to global risk-off events, a secular positive for valuation resilience,” states the report.