Beyond the Index: Why India’s Stock Market Is Entering a New Phase of Divergence

India’s equity markets are at a pivotal juncture. While benchmark indices like the Nifty 50 and Nifty 500 continue to dominate headlines, the real story may be unfolding beneath the surface. A growing divergence between index-level returns and the performance of individual stocks signals that broad market trends are no longer telling the full story. This shift has significant implications for investors, especially those relying heavily on passive or index-based strategies.

According to the latest quarterly commentary by IKIGAI, an alternate investment management firm founded by well-known mid-cap fund manager Pankaj Tibrewal, India’s stock market is entering a phase where selective stock-picking is becoming more critical than ever.

Nifty 500: The Growing Return Gap

The data from the Nifty 500 index paints a stark picture of this growing imbalance. In the fourth quarter of FY25 (January–March 2025), the Nifty 500 declined by 6.8%. However, the median return of the stocks within that index was a much steeper –12.8%. That’s a spread of more than 600 basis points—the widest divergence seen over the past year.

This isn’t just a one-off occurrence. The trend began in the second quarter of FY25 and has only deepened since. It suggests that while the index is buoyed by a small group of high-performing stocks, the majority are facing significant pressure. In essence, the index is masking the real pain being felt across the broader market.

Profit Growth Is Becoming More Concentrated

The widening gap between index performance and median stock returns is more than just a statistical anomaly. It reflects a profound change in the corporate earnings landscape.

In the Nifty 50, only 16% of companies reported profit growth above 25% in Q3 FY25—a sharp decline from the five-year average of 37%. The broader Nifty 500 has seen a similar trend, with just 33% of its companies achieving high profit growth, compared to the historical average of 40%.

This means fewer companies are driving the majority of earnings growth and, by extension, market performance. Investors who fail to identify and invest in these select few are likely to miss out on meaningful gains—even if the index itself appears stable or positive.

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What’s Fueling the Divergence?

Several factors are contributing to this shift:

• Economic Unevenness: While some sectors like banking, defence, and select manufacturing verticals are benefiting from structural tailwinds, others such as consumer durables and small-cap manufacturing are still grappling with weak demand and input cost pressures.
• Liquidity Concentration: Both institutional and retail investors are increasingly allocating capital to “safe” large-cap names with strong balance sheets and consistent earnings visibility. This behavior concentrates gains in a narrow set of stocks.
• Global Headwinds: With ongoing geopolitical tensions and global rate uncertainties, foreign institutional investors (FIIs) are leaning toward companies with strong fundamentals, further amplifying the outperformance of a few names.

Implications for Investors

This divergence presents both challenges and opportunities. Passive investors, who traditionally rely on index funds to capture broad market growth, may see diminishing returns if index gains are driven by a few names. On the flip side, active investors with a strong focus on fundamentals, valuations, and earnings potential can find opportunities in overlooked or undervalued stocks.

It also underscores the importance of disciplined research and active portfolio management. In an environment where a large portion of the market is underperforming, simply “riding the index” may no longer be an effective strategy.

What Should You Watch Going Forward?

As this trend unfolds, here are key signals for investors to monitor:

• Breadth Indicators: Keep an eye on market breadth metrics like the number of stocks hitting new highs versus new lows. A narrowing breadth often precedes increased volatility.
• Earnings Dispersion: Watch how earnings estimates vary across sectors and companies. Greater dispersion often leads to stock-specific market movements.
• Valuation Gaps: Valuation premiums on outperforming stocks can become stretched. Look for opportunities where high-quality businesses are available at reasonable valuations due to temporary sector headwinds.

Conclusion

India is equity market is no longer a broad-based rally where “a rising tide lifts all boats.” Instead, it’s becoming a market of individual stories—where earnings strength, management quality, and strategic clarity separate the winners from the laggards.

As the index increasingly reflects only the success of a few, investors would do well to look beyond headline numbers and dig deeper into the fundamentals. This is a stock-picker’s market now, and those who can adapt to this reality may be better positioned for long-term gains.