Sustained oil prices above $100 a barrel due to a protracted West Asia war, coupled with supply disruptions, could impact corporate earnings and even domestic flows, which have so far absorbed foreign portfolio investor outflows, according to Sachin Bajaj, executive vice-president and chief investment officer at Axis Max Life Insurance.
However, a quick resolution, without further damage to energy infrastructure in the region, could result in a V-shaped recovery in markets, said Bajaj.
Equity markets, both global and domestic, have corrected due to the ongoing war, with the Nifty50 down by over 10% in the past month, a similar story for mid- and small-cap indices. Many of the high-beta names have corrected meaningfully. Over a month into the conflict, commodity prices, especially crude and its derivatives, have seen a sharp rise. As a result, many sectors that are directly exposed have started to be impacted, and there is a growing risk of second- and third-order impacts on corporate earnings for FY27. From hereon, I expect prolonged volatility with further downside risks if oil stays above $100–$110 and the Strait of Hormuz disruptions persist. But any de-escalation could spark a sharp V-shaped rebound in the markets.
Since last July, the small-cap index has corrected around 16–17%, significantly outpacing the 8–10% decline in the large-cap index. The pullback was driven by overstretched valuations for small- and mid-cap stocks relative to earnings growth prospects and their own history. This de-rating has been further accelerated by the war since February. While the valuations for both small- and large-caps have moderated, there is significant uncertainty due to the ongoing war. In the current backdrop, large-caps will act as defensives, while mid- and small-caps present a compelling opportunity as de-escalation takes place.
The ongoing war is a significant headwind for India from a macroeconomic perspective due to our reliance on energy imports. A resolution and ceasefire without further damage to energy infrastructure would be a positive development for our markets and the economy. While crude prices may take time to return to pre-war levels of $60–$65 a barrel, even a drop to around $75 would be a positive signal. In this scenario, I anticipate the rupee will strengthen and equity markets will rebound sharply as risks to corporate earnings growth and foreign portfolio investors (FPIs) subside.
Conversely, sustained oil prices above $100 per barrel and ongoing disruption in global energy supply could put pressure on corporate margins and earnings. In case this conflict prolongs, we could see sustained outflows from FPIs, pressure on corporate earnings, especially for energy-intensive sectors and companies, and it may also impact domestic flows, which could intensify market volatility.
In the current backdrop, the preference would be for a defensive portfolio. Themes such as pharma, healthcare, IT, oil and gas upstream, banks, and defence are expected to outperform the broader index. Meanwhile, sectors likely impacted negatively due to higher crude prices and supply-side disruptions, such as Airlines, travel and tourism, chemicals, and oil downstream companies, can be avoided.
Having said that, after the recent market correction, valuations have become reasonable, with the Nifty50 trading at 17x on a one-year forward basis—below the 5-year average—offering a margin of safety. The war has increased downside risks to earnings; however, if the war ends soon, the hit to earnings will be manageable.
FPIs have been net sellers for several months, driven by capital rotation towards AI themes, relatively higher valuations for Indian markets, and an earnings slowdown. Most recently, FPI outflows have accelerated due to the sharp rise in oil prices and its negative implications for India’s growth. Over the past month, FPIs have sold nearly $13 billion in equities, which is one of the highest recorded figures, while domestic institutions continue to be net buyers, providing critical support to the markets. The war has created significant macroeconomic uncertainty, and FPIs are unlikely to return aggressively until a meaningful de-escalation occurs. Post the recent correction, market valuations have moderated to below the long-term average, and a de-escalation at this stage could bring interest back to Indian equities.