In my last month’s note, I mentioned that the second half of 2025 offers more tailwinds for the equity market compared to the first half. However, July turned out to be a challenging month, with the broader market witnessing a decline and the advance-decline ratio slipping below one. Despite this setback, the reasons behind the market’s downward trajectory are largely explainable and, in many ways, already priced in.

One of the primary triggers for the recent correction has been the tariff imposition by the US. Despite India being among the first countries to engage in bilateral trade discussions with the US, President Trump announced a 25% tariff on Indian exports—one of the steepest among Asian economies. These tariffs are set to come into effect on August 7, 2025. The US accounts for 18.2% of India’s manufacturing exports, and this share has increased to 22.7% in the first four months of 2025 due to pre-emptive exports to mitigate tariff impact. While these numbers might appear modest when viewed against India’s GDP, their significance magnifies when seen in the context of India’s export basket.

Adding to this uncertainty is Trump’s veiled threat of imposing further penalties on India for its continued defence and oil trade with Russia. Such geopolitical rhetoric and unpredictability tend to make markets nervous, as markets inherently dislike uncertainty. Additionally, there is an ongoing legal debate in the US over whether the President has the constitutional authority to unilaterally impose tariffs. While the matter is sub judice, and any adverse verdict in federal court will be escalated to the Supreme Court, my limited understanding suggests that the President may find it difficult to justify these tariffs under existing constitutional provisions. Nevertheless, for now, markets must operate under the assumption that the tariffs will hold.

What’s also evident is that India is not currently in Trump’s “good books.” His recent comments about India have been less than favourable, leading to low expectations regarding any positive outcomes from bilateral negotiations. However, while such developments can trigger short-term corrections, it’s important to note that most of the negative sentiment is already priced in. Thus, the downside risk from these tariff concerns is likely limited.

Amidst this backdrop, India Inc.’s Q1FY2026 earnings season is underway. Contrary to some media commentaries suggesting lacklustre numbers, I beg to differ. As of now, India Inc. has reported a net profit growth of 6.67% for Q1FY2026. Even if we strip out Reliance Industries’ extraordinary gains and BFSI net profit growth is 5.47%. Considering the tariff overhang and rising crude oil prices during the quarter, these results reflect the resilience and adaptability of Indian companies.

More encouraging is the forward-looking commentary from corporate India. Almost every management team has indicated that the second half of FY2026 is expected to be stronger. The worst phase of subdued earnings growth seems to be behind us, and markets will eventually take note of this improving trajectory.

While Foreign Portfolio Investors (FPIs) were net sellers in July, I firmly believe that they will return in the coming quarters as money will flow from developed markets to emerging markets. With robust domestic liquidity flows into mutual funds and favourable macros, we should witness a strong market rally in the months ahead. Several supportive factors—such as corporate tax credits, direct tax cuts, favourable monsoon progress, and the central government’s increased capital expenditure—provide a solid foundation for earnings growth, which will, in turn, support higher equity valuations.

Importantly, the broader market has built a solid base over the past year. Equity as an asset class delivered either muted or negative returns, setting the stage for a sustainable rally. NSE cash data for the first three months of 2025 indicates that retail investors withdrew Rs 13,136 crore from the markets, despite continued positive inflows into mutual funds. This, I believe, is a classic case of recency bias, where investors extrapolate recent underperformance into the future. However, this is a misjudgement. The time has come to increase allocation to equities, as market fundamentals are aligning for a significant upward move.

Over the next 12 months, I expect the Indian equity market to deliver double-digit returns. The downside from current levels appears capped, while the upside potential remains substantial. If that’s the case, why stay on the sidelines? This is the time to ride the next leg of the market rally with conviction.