Energy Prices to Remain Elevated Amid Prolonged Resolution Timeline

Economic Activity May Weigh on Indian Markets Due to Prolonged Conflict Resolution Timeline

According to Harshad Patwardhan, Chief Investment Officer at Union Asset Management Company, a prolonged resolution timeline in the ongoing West Asia conflict could keep energy prices elevated for longer, potentially weighing on economic activity.

The prolonged conflict could result in energy prices staying above pre-conflict levels for some time. Market participants are likely to gradually factor in this evolving reality once more evidence becomes available from the companies involved in the conflict.

FII Flow: Probability of Shift Appears to be Improving

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Patwardhan also expressed his views on the FII flow, stating that while the exact timing of a reversal is difficult to predict, the probability of a shift appears to be improving. This improvement in probability is likely due to signs of stabilization in the Middle East and relatively stronger earnings growth prospects in India compared to the past two years.

Market Expectations: Gradual Movement Towards Diplomatic Resolution

The current market expectation is that the worst of the ongoing Middle East war may be behind us. This assumption is based on the ceasefire announced in early April 2026. The steep panic correction in the market in March 2026 resulted in valuations coming to more reasonable levels. By the end of March 2026, markets were trading broadly in line with 30-year average in terms of one year forward PER (Price-to-Earnings ratio) and as much as two standard deviations below the 10-year average.

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Challenging Quarter Ahead for Corporates

The next quarter may prove somewhat challenging for corporates as the effects of the conflict on higher prices and supply chain disruptions will be felt primarily in this quarter. This will be true even if the truce were to be reached soon. At a company and sector level, the full extent of these headwinds may not yet be completely reflected in market expectations.

FII Selling Nearing Exhaustion

FII selling in the secondary market stood at approximately US$14.6 billion in March 2026, marking one of the highest monthly outflows on record. Over a longer period, FIIs have remained net sellers in Indian secondary markets, and positioning appears to be significantly underweight from a historical perspective.

Small-Cap and Nano-Cap Stocks to Outperform

In this phase of change in direction in the markets, small-cap and nano-cap stocks often outperform the broader market initially. However, we expect broader markets including large/midcaps to participate, particularly when foreign flows start to improve.