Stock market returns, globally, have been impressive in 2025. The return from MSCI World Index up to early December this year was 20.9%. A major part of the returns has come from AI-linked stocks. Nearly 75% of S&P 500’s return in 2025, up to early December, has come from AI-linked stocks. Clearly, 2025 has been a year of AI boom in the market. ‘AI gainers’ like the US, China, Taiwan, and South Korea gained handsomely in 2025 from the AI boom. India, an ‘AI loser’, couldn’t participate in the AI boom. Therefore, India underperformed in 2025.
What are the threats to the market in 2026?
What are the opportunities?
The foremost threat to stock markets is a potential ‘AI bubble’ burst, impacting stock markets globally. The launch of OpenAI’s ChatGPT in November 2022 was a transformative event with profound consequences. ChatGPT became the fastest growing consumer app in history, reaching 100 million users within months. This has triggered an investment race among tech giants looking to benefit from the widespread use of AI. Investors looking for gains from the AI bonanza have been madly buying AI stocks, pushing up their stock prices. Comparisons are drawn to the tech bubble of the late 1990s and its collapse in 2000 impacting stock markets globally and pushing the global economy into recession.
Will history repeat?
AI stock prices are high, but not yet in bubble territory
Going by traditional norms of valuations, like the PE ratio, AI stock prices are not in bubble territory. At the peak of the 2000 tech boom, the Nasdaq PE was around 90. Most internet companies, which were making losses, had unjustifiably high valuations. Many stocks were trading at PE ratios of above 150, clearly bubble valuations. In contrast, the present valuations of AI stocks are not excessive, though high. For instance, in mid-December 2025, the chip leader Nvidia is trading at a PE of 46. The PE ratios of the large AI players in early December are as follows: Microsoft 35, Apple 37, Amazon 32, Alphabet 32, and Meta 29. These are not bubble valuations. Also, these are cash-rich companies. However, the concern is that these tech giants and other AI companies are making huge investments based on hope, and these investments may not generate returns to justify their high valuations. The hope may end in despair, resulting in a crash in stock prices.
Correction in AI stocks likely in 2026
A recent Bank of America survey indicated that 45% of global fund managers believed that the biggest risk to global markets in 2026 is a bubble burst in AI stocks. A correction in AI stocks is a high probability event in 2026. If there is a major crash, led by a crash in the US stock market, all stock markets will be impacted globally. But a major crash is unlikely, since big buying will emerge at lower levels. If it is a correction in AI stocks, say by 10 to 20%, that would be a positive for markets like India.
Growth and earnings rebound
FIIs sold heavily in India in 2025 and moved the money for the AI trade, which fetched them good returns. A likely scenario in 2026 is a correction in AI stocks and FIIs turning buyers in India. India’s GDP growth has rebounded impressively with 8.2% growth in Q2 FY26. With CPI inflation climbing to 4% in FY27, nominal GDP growth can rise to around 11%. Corporate earnings have the potential to rise by 15% in FY27. Robust economic growth and improving corporate earnings in India, along with a correction in AI trade, can facilitate the reversal of FII outflows and decent returns from the market in 2026. In a bull case scenario, Nifty stands a good chance of reaching the 30,000 mark.
The new Nifty high didn’t benefit majority of retail investors low of 7,511 to 26,216 in September 2024 was a spectacular widespread rally which benefited all investors. But the recent rally to the new high of 26,325 was a low-key rally sans celebration in the market. This narrow rally, led by a few large caps, didn’t benefit most retail investors, particularly the newbies whose portfolios are dominated by small caps. failure to benefit from the market rally was the consequence of wrong investment strategy.
For about a year now, we have been advising investors to reduce exposure to small caps and increase exposure to large caps and very selectively to mid-caps. The broader market valuations had reached unjustifiable levels, warranting corrections. Market experience tells us that when valuations rise to unjustifiable levels, reversion to mean is inevitable. This will happen; only the timing is unpredictable. As 2025 draws to a close, this reversion to mean has happened in the broader market, particularly in small caps. In mid-December 2025, Nifty small cap index is down 9% YTD and down 13% from its peak.
Continue with the multi-asset investment strategy but with equity bias
For 2025, we had recommended a multi asset investment strategy with exposure to equity, gold, and fixed income. This strategy can be slightly tweaked in 2026 with bias towards equity and reducing exposure to fixed income. Since interest rates have troughed out, returns from bonds will be subdued in 2026. In equity, the overall valuations in the small cap segment continues to be high. Safety and growth potential are in large caps. For mid caps, even though the valuations are high, the tailwind of earnings growth is strong.
