SmallCap & MidCap Stocks: The Indian stock market has been experiencing heightened volatility, with foreign institutional investors (FIIs) offloading their holdings and liquidity tightening. The small- and mid-cap (SMID) segment has been hit the hardest, correcting nearly 15% since September. The BSE 400 Small & Midcap Index is now on track for its fifth 20%+ correction since the global financial crisis (GFC).
This sharp fall has left investors wondering: Is this just a temporary dip, or are we entering a prolonged bear market? Let’s break it down.
Blip or Bear Market: SmallCap & MidCap Stocks Plunge
The small- and mid-cap segment has experienced multiple corrections in the past. Some were temporary blips, while others turned into full-fledged bear markets.
According to Nuvama Institutional Equities, market corrections can be categorized into two types:
- Blips: Short-lived corrections (2–3 quarters) where SMID stocks fall in line with large-cap stocks. Previous instances include 2015–16 and 2021–22.
- Bear Markets: Prolonged corrections lasting 2–3 years, with a 30–40% decline and significant underperformance relative to the Nifty 50 and Sensex. Past examples include 2011–13 and 2018–19.
Historically, bear markets in the SMID space occur when domestic credit slows down, liquidity tightens, and stocks have already had a strong five-year rally. Blips, on the other hand, tend to happen due to global weakness, while domestic factors remain stable.
What’s Driving This Correction?
The current downturn is showing signs of a bear market rather than a short-term blip. Here’s why:
- Slowdown in Domestic Growth:
- The domestic credit cycle, which was strong in 2023, has moderated sharply in the first half of CY24.
- A weakening credit cycle is a major red flag for small- and mid-cap stocks, as they rely more on domestic demand than large-cap stocks.
- Earnings Underperformance:
- Excluding the BFSI (Banking, Financial Services, and Insurance) sector, SMID earnings have started contracting.
- Even in Q3FY25, earnings have been disappointing, with several stocks facing downgrades.
- Valuations Still Elevated:
- Despite a 15% correction, valuations remain higher than previous peaks, making these stocks expensive relative to historical averages.
- Liquidity Tightening:
- With the US Federal Reserve’s stance on interest rates, global liquidity conditions have become tighter, making it difficult for small- and mid-cap stocks to sustain their rally.
- FIIs Selling Aggressively:
- FIIs have been reducing their holdings, putting additional pressure on mid- and small-cap stocks.
What History Tells Us
Looking at past corrections, we notice that bear markets in the SMID segment tend to follow periods of strong returns.
- Blips tend to follow a 10–15% five-year return.
- Bear markets, however, come after prolonged 5-year bull runs (20%+ annualized gains).
Currently, SMID stocks have significantly outperformed the Nifty 50 and Sensex over the last five years, which aligns more with bear market conditions rather than a short-term correction.
Sector-Wise Impact
- Cyclical sectors like real estate and industrials typically suffer the most in a bear market, often correcting by over 50%.
- Defensive sectors such as FMCG and pharma tend to perform better in such conditions.
Way Forward for Investors
With domestic growth slowing, liquidity tightening, and valuations still stretched, this correction resembles the 2011–13 and 2018–19 bear markets more than a temporary blip.
What should investors do now?
- Avoid high-beta stocks: Stocks with high volatility can see deeper cuts.
- Focus on defensive sectors: FMCG, pharma, and sectors with strong demand resilience may provide stability.
- Watch the US Federal Reserve: Past bear markets have reversed when the Fed has changed its stance on liquidity.
- Stay away from cyclicals for now: Real estate and industrials may see further pain if the downturn deepens.
Final Thoughts
While some investors may be tempted to “buy the dip,” history suggests that bear markets in the small- and mid-cap space can last for multiple years. Investors should be cautious and prioritize capital preservation over aggressive buying.
Instead of rushing into the market, monitor key indicators like the credit cycle, global liquidity trends, and FII activity. If history is any indication, the SMID segment may still have room for further correction before a sustained recovery begins.
Key Financial Ratios to Track
| Metric | Current Trend |
|---|---|
| P/E Ratio (Price-to-Earnings) | Elevated despite correction |
| P/B Ratio (Price-to-Book) | Higher than historical averages |
| FII Activity | Heavy outflows |
| Domestic Credit Growth | Weakening |
| SMID Earnings Growth | Underperforming large caps |
This time, the signs are pointing towards a bear market, and investors should tread carefully. Instead of chasing quick rebounds, a disciplined, low-risk strategy could be the best way forward.
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Disclaimer: This blog post is for informational purposes only and should not be considered financial advice. Investors should conduct thorough research and consult with a qualified financial advisor before making any investment decisions.