Smallcap and midcap stocks are making a strong comeback after enduring a harsh and prolonged correction over the past six months. This resurgence has come as a welcome relief to retail investors, many of whom have significant exposure to these broader market segments. Known for their potential to deliver outsized returns compared to large-cap stocks — albeit with greater volatility — smallcap and midcap stocks had been riding high on the back of the market boom in 2023, leading to significant overvaluation.
However, the tide began to turn in late 2024 as a sharp market correction dragged numerous smallcap and midcap stocks down by 60-70%, eroding much of the previous gains. This correction, while painful for many investors, has brought valuations closer to more reasonable levels, leading some analysts to suggest that fundamentally strong stocks in these segments could start showing signs of recovery.
The question that remains, however, is whether this rebound will extend to smallcap and midcap mutual funds. Experts speaking to IndiaToday.in expressed mixed views. While acknowledging the recent partial recovery, they cautioned that overall valuations are still on the higher side and may not yet be attractive enough to fuel a sustained rally.
Nilesh D Naik, Head of Investment Products at Share.Market (PhonePe Wealth), pointed out that despite the market’s rebound, current valuations combined with a noticeable slowdown in earnings growth make it unlikely that smallcap and midcap stocks will reclaim their previous highs in the near term. He acknowledged that certain high-quality stocks within these segments may now present some valuation comfort, but the broader market remains relatively expensive.
Naik suggested that long-term investors who believe in the growth potential of smallcap and midcap stocks could consider gradually increasing their exposure to these segments by systematically accumulating mutual fund units. However, he warned that investors must have the "risk tolerance to withstand the higher volatility associated with these segments," emphasizing that these stocks tend to be more sensitive to market cycles, liquidity changes, and global factors.
Offering a broader perspective, Sandeep Bagla, CEO of TRUST Mutual Fund, argued that the traditional classification of Indian stocks into large, midcap, and smallcap categories is outdated and warrants an overhaul. He explained that many companies previously considered small have now grown significantly in size and influence, blurring the lines between these segments.
Bagla further emphasized that India remains a "structural growth story" despite the current cyclical slowdown. He projected that by the start of the next financial year, a more favorable economic environment — driven by easier monetary policies, lower interest rates, and improved lending and liquidity conditions — should set the stage for an economic recovery. This recovery, he argued, would likely pave the way for a fresh rally across the broader markets, including smallcap and midcap stocks.
Bagla also noted that the Indian market is inherently forward-looking, often pricing in future growth ahead of visible recovery signs. He suggested that patient, long-term investors are likely to benefit the most from this scenario, as midcap and smallcap stocks historically tend to outperform during economic rebounds.
For investors contemplating whether now is the right time to re-enter the smallcap and midcap segments through mutual funds, Bagla’s advice was clear: adopt a long-term perspective and focus on high-quality, well-managed funds. He stressed that these segments are likely to "deliver rich dividends for discerning and patient investors" over an extended investment horizon, particularly once the economic cycle shifts into a growth phase.
In summary, while smallcap and midcap stocks have shown signs of recovery after a brutal correction, experts remain cautious about their short-term performance due to still-elevated valuations and earnings slowdowns. That said, for long-term investors with a strong risk appetite and the patience to weather volatility, the current environment could present an opportunity to gradually build exposure. The road ahead may still hold turbulence, but history suggests that those who stay the course and focus on quality investments could reap substantial rewards when the next growth cycle takes hold.
