Small, Mid Caps To See More Downside As Stocks Near Bearish Territory
The fall in small stocks has been sharp, with foreign selling and domestic portfolio reallocation towards larger names, Bernstein said.
India's small and mid-cap stocks are poised for further downside, as these stocks are testing the entry into the bear market on muted earnings and peaking domestic flows, according to Bernstein Research.
The broader market extended its fall on Tuesday, with the midcap index down 3.44% and the small-cap index slipping 3.84%. The benchmark indices—Nifty Smallcap 250 and Nifty Midcap 150—fell as much as 18.8% and 16.3%, respectively, from their previous peak last year.
About 75 of 150 midcap companies' shares have fallen over 20% from their highs, while 121 of 250 small caps have fallen over 20% from their highs, according to data compiled by NDTV Profit.
The earnings growth and valuations, the flow cycle covering domestic and foreign inflows, and the investor sentiment looking at SIPs from the retail section are key triggers for Bernstein's cautious look.
The earnings revisions continue their downward trajectory with fiscal 2026 earnings estimates revised downside, Bernstein analysts' — Venugopal Garre and Nikhil Arela — said in a note. Despite these downward revisions, cases of earnings missing their estimates are near multi-year highs, the note said.
Further, the valuations "are still hefty", Bernstein said. This results in the longest period of SMIDs trading above their historical averages and leaving significant room for decline before stabilising, it said.
The domestic flows, which have helped small and mid-caps rally, seem to have peaked, the analysts said. Domestic mutual fund ownership of NSE-listed firms is now at a record high of 9.5%, and inflows in small and mid funds have been as high as 2.5 times those of large caps, the note said.
The domestic flow cycle has peaked, and investor sentiment is shifting, with trailing 12-month SIP returns turning negative for the first time in almost two years, it said.
The fall in small stocks has been sharp with foreign selling and domestic portfolio reallocation towards larger names, Bernstein said. The research firm does not expect these small caps to outperform large caps in 2025.
"We are, however, building in for peaking of foreign outflows, which have already brought the cumulative FII flows below their five-year average." But, this is likely to help the larger names more, Bernstein said.
Small caps see several risks that may cause further correction, Bernstein said, as they expect some recovery in the second half of the year. As foreign outflows stop and domestic reallocation is behind, a recovery should emerge in the second half, it said. "Sharp corrections in SMIDs, however, will likely offer opportunities to resurrect a dedicated strategy later this year."
