Smallcaps Are Bucking The Market Sell-Off While Largecaps Suffer: Here’s Why

The recent market correction has not hit all stocks equally. Large caps have taken a bigger beating, while small caps have remained relatively resilient.

The Nifty 50 is down 12.83 per cent year-to-date, while the Nifty Midcap 100 has fallen 1.20 per cent. The Nifty Smallcap 100, in contrast, has gained 9.80 per cent.

The recent eight-week sell-off shows the same trend. The Nifty 50 fell around 8.75 per cent, while the broader Nifty 500 lost 7.82 per cent. The Nifty Midcap 100 declined 7.45 per cent, but the Nifty Smallcap 100 fell a little over 4 per cent.

The key question is why smallcaps have held up better despite pressure from US yields, the dollar, crude prices and foreign selling.

What Triggered The Correction

The current correction has largely been driven by global macro risks. The US 10-year Treasury yield touched 5.32 per cent, its highest level since 2002. It had fallen below 4 per cent before the US-Iran war began in late February. Higher US Treasury yields make emerging-market assets relatively less attractive and increase the cost of capital.

That has also changed expectations around the Federal Reserve. Markets that were earlier pricing rate cuts have started factoring in the possibility of another rate hike by the end of the year. The outlook, however, has swung with every development around the US-Iran conflict.

The dollar has moved higher as the rate outlook has changed. The Dollar Index was around 102 on October 6, up nearly 3 per cent in a month. The rupee, meanwhile, fell to 96.50 against the US dollar, down 2.14 per cent over the same period.

Crude oil prices have made things harder for India. Brent has hovered over $100 a barrel for most of the last eight weeks as concerns over prolonged supply disruptions increased. Higher crude prices, coupled with a weaker rupee, can raise India's import bill, add to inflation and squeeze corporate margins.

Foreign portfolio investors (FPIs) have responded by cutting exposure to Indian equities. According to NSDL data, FPIs sold Indian equities worth Rs 35,861 crore in September, followed by another Rs 22,676 crore in the first three sessions of October. Their net sales have reached Rs 2.83 lakh crore so far this year.

Domestic Money Is Cushioning Smallcaps

The biggest reason smallcaps are holding up better is domestic liquidity. N ArunaGiri, founder and CEO of TrustLine Holdings, an equity research and asset management firm, said sustained mutual fund and systematic investment plan (SIP) flows have changed the way smallcaps behave during corrections.

"The key driver behind the resilience and relative outperformance of small-caps appears to be the structural increase in domestic liquidity, particularly sustained flows through mutual funds and SIPs," he said.

"Domestic equity flows through mutual funds have risen from around Rs 1–1.5 lakh crore annually to Rs 4–5 lakh crore, while SIP flows have reached around Rs 25,000 crore a month."

According to the Association of Mutual Funds in India (Amfi), small-cap funds attracted Rs 7,973.33 crore in August, while midcap funds received Rs 6,989.40 crore. In July, the two categories saw inflows of Rs 7,767.50 crore and Rs 6,192.31 crore, respectively.

Large-cap funds, on the other hand, recorded outflows for the second straight month. Investors pulled out Rs 1,147.36 crore in August after withdrawing Rs 1,321.69 crore in July.

SIP contributions stood at Rs 32,297 crore in August, up 14.3 per cent from a year earlier.

"This persistent domestic liquidity has changed the behaviour of small-caps during the downcycle, making corrections shallower than in previous cycles," ArunaGiri said.

FPI Selling Is Hurting Largecaps More

NSE's India Ownership Tracker shows institutional allocation to Nifty 50 stocks fell 3.1 percentage points quarter-on-quarter to a record low of 56.1 per cent in the June quarter. FPI allocation to the top 10 per cent of stocks by market capitalisation also fell to 89 per cent, its lowest level in six years.

Harsh Gupta Madhusudan, chief equity strategist at Ionic Asset, said the difference in ownership has helped small and midcaps during the recent FPI selling. FPIs have a larger presence in large caps, so their selling has created more pressure there. In small and midcaps, domestic institutional buying has faced less selling pressure, he said.

Are Smallcaps Less Exposed To Global Risks

Only partly. Smaller companies tend to have greater exposure to India's domestic economy than some large export-oriented companies. That can make them less sensitive to a stronger dollar, weak global demand and higher US yields.

Madhusudan also cited "lower exposure to exports or the negative AI narrative" as a factor behind the stronger performance of small and midcaps.

But domestic exposure does not make smallcaps immune to the global shock. Higher crude prices can raise input and logistics costs, while a weaker rupee can increase the cost of imported inputs. Higher interest rates can also hurt companies with high debt.

Earnings Are Helping

Better earnings growth is another factor supporting smaller companies. Madhusudan said small and midcaps delivered stronger earnings growth than largecaps in the first half of FY27, from April to September.

"H1FY27 saw a strong relative performance by small and mid caps coming off the 31 March lows. Earnings growth has been stronger than large caps on the whole," he said.

But investors are paying a higher price for that growth.

Madhusudan estimates that smallcaps were trading at around 34 times their pre-September results price-to-earnings (P-E) ratio, compared with 28 times for midcaps and 19 times for largecaps.

"Being broadly neutral with perhaps a small edge to SMIDs is sensible now given the momentum factor," he said, adding that a strong September-quarter earnings season for large caps could change that view.

High Valuations Are The Catch

The valuation gap is the biggest risk to the small-cap rally. ArunaGiri said smallcaps are still expensive overall, even though their valuation floor is higher than in previous cycles.

"The aggregate small-cap index had reached around 30–35 times earnings at the peak and, even after the subsequent downcycle, corrected only to around 25–26 times, compared with the low-teens levels seen in previous cycles," he said.

Stock valuations also vary widely. Some momentum-driven businesses are trading at 50–60 times earnings, while companies facing near-term earnings weakness are valued in the low teens, ArunaGiri said.

Because of this, he does not see the current strength in small caps as a reason to buy the segment as a whole.

"The current resilience should not be interpreted as a blanket buying opportunity across the small-cap universe," ArunaGiri said.

For long-term investors, he sees opportunities in select companies in sectors that have seen sharp valuation cuts, including IT, product software, banking, cement and consumer durables. He said investors should focus on individual businesses rather than simply buying a sector or a particular market-cap segment.

The Cushion Has Limits

Smallcaps have so far benefited from a combination of strong domestic flows, lower FPI ownership and better earnings growth. That has helped them absorb the current bout of foreign selling better than large caps.

But the gap may not remain this wide if global risks persist.

If US yields and crude stay elevated, the rupee weakens further, or domestic equity flows slow, smallcaps could also come under pressure. Their higher valuations leave less room for earnings disappointments.