Prepare, Not Predict

‘Make hay while the sun shines’ — recent geopolitical events have only highlighted the importance of this old English proverb. In financial markets where the supply of capital is limited, this proverb gains a lot more importance as it seeks to drive investors to take rational financial decisions. But we humans are far from being ‘rational’.

We are driven by emotions, greed and fear. It is greed that takes off our focus from risk. The trade-off for risk is return; i.e., if you want lower risk, then you must accept lower returns. It is easier said than done as greed takes over. This ongoing cognitive dissonance in investors’ minds can either create a roadblock or can be harnessed effectively to create a more stable return profile for their portfolios.

These arguments might sound conservative but are constructive in the current volatile world. It only took a few months of a difficult geopolitical situation in the Middle East to wreck socio-economic havoc on countries across the globe. It has served as a harsh reality check for governments, industries and consumers alike.

One of the greatest financial minds of our times, Mr Howard Marks, says, ‘prepare, not predict’. Let us try to understand this with an example of two questions:

1. Will the recession come?

2. Will the recession come next year?

The first question involves predicting an event (one variable), which is difficult but conceivable. The second question adds another variable, ‘time’. Predicting the timing of the event is nearly impossible. However, the projected returns from a particular event can appear highly lucrative and often drive investment decisions.

It is relatively easy to think about the extreme scenarios. The best- and worst-case outcomes are rare occurrences, akin to Black Swan events. Someone predicting a recession would hoard large cash positions, and someone who believes in the blue-sky scenario will be fully invested. Predicting binary events leads to a skewed portfolio construction. This reminds me of the words of legendary fund manager Mr Peter Lynch, ‘More money is lost predicting a recession/correction than the actual event’.

Thus, we need to ‘prepare’ rather than trying to ‘predict’ any event.

How Do We Prepare?

A portfolio’s ability to absorb external shocks comes from ‘diversification’. Optimal position sizing, or prudent allocation of capital among the stocks in the portfolio, is one of the most important enabling factors that allows diversification. A large overweight position or asset allocation in any particular sector leaves less money for other sectors, leading to sub-optimal results.

We see diversification on multiple levels within a portfolio, across sectors, themes, styles (growth, value, momentum), factors (size, valuation, quality, volatility, etc.) and geographical exposures.

Market Outlook

The AI-led rally in developed markets (especially the US) and rising interest rates have redirected global capital away from emerging markets. India has been perceived as a relative laggard in the AI-driven global investment cycle. As a result, FPI positioning in India is now approximately 2 standard deviations below historical averages, indicating extreme under-ownership.

The ‘India - AI laggard’ tag needs reassessment. This narrative may be overly simplistic, as the second-order implications of AI in developed markets (margin pressure, disruption, capital intensity) remain underappreciated. On the other hand, India continues to offer structural growth with lower disruption risks, driven by domestic demand and ongoing formalisation. We believe as the AI trade matures, relative attractiveness will rebalance in India’s favour.

Simultaneously, India’s valuation premium has compressed sharply and is now approaching long-term mean levels, removing a key deterrent for flows.

This implies that the market is transitioning from a phase of flow-driven de-rating to potential flow normalisation, with limited incremental selling risk.

While the last two years have not been particularly exciting, we are seeing some positives emerge on the horizon.

1. 4QFY26 Nifty revenue growth of 11 per cent is the best in the past seven quarters, driven by Auto (Ex - TTMT), NBFCs and Metals, while Nifty domestic revenue growth at 17 per cent (excluding Indigo) for 4QFY26 is the highest in the past 12 quarters, contributed by Consumption, Auto and Power.

2. On the macroeconomic front, RBI’s June 2026 MPC policy announcements, along with tax amendments notified by the Government, reflect a coordinated effort to attract foreign capital into India’s debt markets and banking system. This could lead to greater participation by foreign investors in government borrowing, reducing dependence on domestic banks and potentially freeing up liquidity for retail and corporate lending.

3. Domestic demand remains robust as indicated by:

• Auto volumes, especially UVs, reported robust growth and continued to outpace passenger-car growth. Tractor growth (35 per cent) is the strongest in the past 16 quarters.
• IT wage growth outpaced the overall market at approximately 10 per cent despite a net reduction in headcount.
• Credit costs continued to moderate for Banks and NBFCs; asset quality continued to improve.
• For Pharma, Indian formulations remain a robust growth engine primarily driven by chronic therapies.
• Residential real estate demand continues to be robust, especially in the premium category, as indicated by strong pre-sales numbers.

Key emerging risks include (1) a persistently uncertain outlook for the IT services sector and (2) the potential for a prolonged West Asia crisis, which could exacerbate policy trade-offs among growth, inflation and currency stability.

As on June 29, 2026, on Bloomberg consensus, the Nifty 500 Index was trading at 19.0x CY27 expected earnings. The consensus seems to have factored some war impact on corporate earnings. EBITDA margin for the Nifty 500 Index is expected to decline year over year by nearly 140 bps to 18.2 per cent due to higher crude and other derivative prices. Recovery is expected to follow in CY27.

India’s corporate earnings are entering a fascinating phase, one that is anything but uniform.

According to consensus estimates, CY25–CY27 reveal a multi-speed growth story across large, mid and small caps. While some segments promise stability, others are gearing up for explosive growth and a few will test investor patience before rewarding conviction.

If one is planning their portfolio for the next three years, understanding these dynamics is critical. Here is what the numbers tell us and why the allocation strategy matters more than ever.

Given the expected earnings, Small and Midcaps are trading at reasonable multiples relative to their growth potential, offering better risk-adjusted returns. They are expected to combine higher earnings momentum, attractive valuations and structural growth drivers, making them, selectively, a preferred investment opportunity for investors seeking alpha in the next three-year cycle.

Disclaimer: The opinions expressed above are of the author and may not reflect the views of DSIJ.