Market Correction and Domestic Stability

Global and Market Context

Global financial markets began 2026 with a more cautious tone, as investors reassessed risk positioning following an extended period of strong equity performance across major markets. While global macroeconomic conditions remain broadly stable, elevated valuations in several asset classes and evolving capital flows contributed to increased volatility across emerging markets. Within this backdrop, Indian equities experienced a notable pullback during January, reflecting both global risk sentiment and continued foreign portfolio outflows. The correction was particularly pronounced in segments of the market that had previously experienced significant valuation expansion, most notably small- and micro-cap stocks.

Despite these near-term pressures, India's structural investment case remains intact, supported by strong domestic savings flows, resilient corporate balance sheets, and steady credit expansion across the financial system.

Market Overview

Indian equities declined during January, with the Nifty 50 falling 5.0% and the Sensex declining 5.4% over the month. The correction was broader across the market, though the most significant drawdowns were observed in mid- and small-cap segments, where valuations had previously reached elevated levels. A key theme during the month was sector dispersion, with cyclically sensitive sectors outperforming while several growth-oriented segments experienced modest corrections. Notably, the Nifty Metal Index rose 5.9%, emerging as the strongest-performing sector during the period.

Importantly, domestic institutional investors continued to provide a stabilizing force, offsetting a meaningful portion of foreign selling pressure and helping absorb liquidity during the market adjustment.

Key Market Developments

Repricing Across Smaller Capitalization Stocks

Small-cap and micro-cap stocks experienced a sharp correction during the month, reflecting a normalization following a period of strong outperformance and valuation expansion. Investor positioning in these segments had become increasingly crowded, leaving them more sensitive to shifts in risk sentiment. Such corrections are not uncommon following strong market rallies and often represent a healthy recalibration within broader equity market cycles.

Currency Weakness Adds to Market Caution

The Indian rupee depreciated approximately 2.0% during January, closing near 91.7 against the U.S. dollar. The pace of depreciation was somewhat sharper than typical monthly moves and contributed to a more cautious stance among global investors. While currency movements can influence near-term capital flows, the impact on underlying corporate earnings remains sector- and company-specific.

Subdued Inflation Environment

Domestic inflation remained benign, with CPI inflation at 1.33% year-on-year. The muted inflation backdrop provides a relatively supportive macroeconomic environment, although investor sentiment during January was driven primarily by global positioning and capital flow dynamics rather than domestic macro indicators.

Market Performance and Internals

Market volatility increased during the month. The India VIX rose from approximately 9.5 in December 2025 to around 13.6 by the end of January, representing a 43% increase in implied volatility. While this move marks a notable increase, volatility levels remain moderate relative to historical periods of market stress, suggesting that the adjustment thus far reflects a recalibration in investor sentiment rather than systemic risk.

Sector Performance: Metals outperformed with +5.9% returns, followed by PSU stocks at +5.8%, while Autos and Healthcare declined 5.1% each. Oil & Gas fell 3.6%. This dispersion highlights the rotational nature of the current market environment, where investors are selectively reallocating capital across sectors.

Institutional Flow Dynamics

Capital flows remained a dominant driver of market performance during January. Foreign Portfolio Investors (FPIs) recorded net outflows of approximately $4.5 billion (₹41,000+ crore) during the month. The continued selling largely reflects global allocation adjustments and risk positioning, rather than a deterioration in India's economic fundamentals.

In contrast, Domestic Institutional Investors (DIIs) remained strong buyers, recording net inflows of roughly $7.5 billion (₹69,000+ crore). These dynamics underscore a structural shift within Indian capital markets, where domestic savings flows are increasingly acting as a stabilizing counterbalance to foreign investor volatility.

Portfolio Positioning

The portfolio remains focused on sectors where structural growth drivers, improving fundamentals, and valuation discipline intersect. Our core allocations include:

Automobiles: The automobile sector continues to benefit from improving demand visibility, ongoing product cycle upgrades, and operating leverage across manufacturers. Structural themes such as premiumization and innovation remain supportive for earnings growth.

Metals: Our exposure to select metal companies reflects constructive supply dynamics, strengthened balance sheets, and disciplined industry capacity expansion.

Financials: Financials remain a core portfolio allocation, supported by healthy credit growth, stable asset quality, and continued improvements in operating efficiency across leading institutions.

These allocations represent structural positioning rather than tactical short-term bets. Portfolio construction remains disciplined, with continuous monitoring of factor exposures, correlations, and position sizing to ensure resilience across varying market regimes.

What We Are Watching

Looking ahead, several factors will remain important for market direction:

• Global capital flow trends: Foreign investor positioning toward emerging markets will continue to influence near-term market dynamics.
• Currency stability: The trajectory of the Indian rupee will remain an important variable for foreign investor sentiment.
• Earnings visibility across cyclicals: Sectors benefiting from operating leverage and industry consolidation may continue to attract investor interest.
• Valuation normalization in broader markets: The recent correction in small- and mid-cap stocks may lead to more selective investment opportunities over time.

Closing Perspective

Market corrections and periods of heightened volatility are an inherent part of long-term investing. Importantly, they often create opportunities for disciplined investors to accumulate high-quality businesses at more attractive valuations. Our investment approach remains centred on consistent generation of risk-adjusted alpha, rather than attempting to predict short-term market movements. We continue to refine factor definitions, rebalance exposures selectively, and allocate capital toward opportunities where valuation discipline, business quality, and structural growth drivers align.

As always, our priority remains protecting capital during periods of market stress while remaining well positioned to participate in long-term wealth creation within Indian equities.