SmallCap's Big Crash: SmallCap Index Declines Over 20 Per Cent From 52-Week High - How To Navigate The Downturn 

Indian equity markets ended their six-session losing streak on February 13 as the benchmark Nifty opened in the green at 23055.75 levels, up by 0.04 per cent or 10.5 points, the 30-share Sensex also opened in the green at 76201.1 levels, up by 0.039 per cent or 30.02 points.

As the benchmark indices witnessed a brief respite, the SmallCap and MidCap indices also opened in the green after hitting an 8-month low on February 12. The Nifty SmallCap 100 opened at 16,024.2 levels down by 0.054 per cent, however at the time of writing this story the index gained 0.62 per cent to trade at 16,133 levels. On the other hand the Nifty MidCap 100 opened at 50,856.40 levels, up by 0.19 per cent.

On February 12, the Nifty SmallCap 100 index hit a low of 15,490.1, down 21.43 per cent compared to its 52-week high of 19,716.2. The Nifty MidCap 100 also fell nearly 19 per cent from its 52-week high of 60,925.95 to trade at a low of 49,357.65. With the 20 per cent fall the small-cap index has entered bear territory. Notably, if an index falls 20 per cent or more from its 52-week high, it is termed a market crash or a bear market.

What Led The Indices Into Bear Territory?
Several factors have contributed to the decline witnessed by both small-cap and mid-cap indices such as uncertainty over US President Donald Trump's policy moves, a fresh tariff strike, weakening rupee and a lacklustre earnings season along with continued selling by Foreign Institutional Investors (FIIs).

High Valuations

Prashanth Tapse, Senior VP Research at Mehta Equities Ltd. told Outlook Money that ‘high valuations’ were a key reason behind the corrections seen in smallcap and midcap stocks. He added that nearly two years ago there was a lot of liquidity in the market but fewer opportunities in the large-cap space, which made investors invest heavily in small-caps and mid-caps, this influx in turn increased the valuations of small-cap and mid-cap stocks, making them expensive.

“These two indices rallied a lot two years back, one reason was less opportunities and high liquidity. So less opportunity in large-caps and huge opportunity in terms of mid-caps and small-caps the liquidity pushed the valuations of these two indices very high. As high as more than 10 years average of any mid-cap on small-cap stock,” Tapse said.

Mismatch Between Earnings Growth And Price Action

Tapse added that there’s a mismatch between the earnings growth of Indian companies and the kind of price action seen in the stock market. Tapse added that all three quarters of FY 2025-26 have been disappointing, on the other hand, stocks have continued to rally, this mismatch has led to sell-offs or profit-booking which has led to corrections in the small-cap and mid-cap space.

“There was no earning growth, if you see Q1, Q2 and Q3 of FY25 they were all disappointing. So there is a mismatch between earnings growth and price action. If a stock had rallied by 2x and 3x in one-year, similar kinds of earnings have not been reported. So that has led to major sell-offs or profit-booking,” Tapse said.

Macroeconomic Factors

Tapse added that several macroeconomic factors have also contributed to the downturn such as the Gross Domestic Product (GDP) being at a 24-month low, low Index of Industrial Production (IIP) and high inflation. Notably the projected growth rate for India’s GDP is 6.3-6.8 per cent for 2025-26 as per the Economic Survey. However, Tapse projected that there may be a normalisation in earnings growth by the first quarter of FY26 due to a consumption push made in the Union Budget 2025.

“You know how inflation has played well in Indian markets. Today's IIP numbers are still not good, then again Q3 numbers, overall Indian GDP is down. However post-budget, one thing is sure, in the next six months there may be some kind of visibility in terms of earnings growth due to the consumption push by the budget. I am taking a call for the next two quarters, that is Q4 of this financial year and Q1 of next financial year. So there should be some kind of neutral growth or positive growth. On this basis I am assuming after 6 months we may come back to a normalisation in terms of earnings growth,” Tapse said.

What Can Investors Do In The Crash?

Tapse added that long-term investors do not need to worry amid the downturn. He said that the current correction seen in the mid-cap and small-cap space is ‘medium term’ for investors who have been invested for 5 to 10 years. He added that the correction in the small-cap and midcap space was likely to extend or consolidate in the next three to six months.

“Long-term investors need not to worry. Long-term investors who have been in the market for 5 years to 10 years don’t need to worry because this correction would be very medium-term, maybe another three to six months can be a time where this correction can extend or consolidate,” Tapse said.

On the other hand, Tapse said that new investors will feel the pain of the correction more, especially if they have entered the market recently. He added that on a five-year basis, the stock is expected to perform again. However, Tapse advised investors to reassess and review their position if a stock is down by 50-70 per cent from its peak.

“If I invested very recently, for example, if you invested in a small cap or midcap one year back, you may face a little bit more pain for a very short period of time. But again, if you see a five-year cycle again those stocks will perform. However, if a stock is down by 50, 60 or 70 per cent from its peak it is very necessary to understand why this stock has come down by this per cent and then do some review on the stock on the sector and then take a call. My advice would be to go for stocks of fundamentally strong companies,” Tapse said.