The Indian equity markets present a striking paradox. Mega companies are struggling with their businesses as if India is in a recession, yet their stock prices remain firm. Scores of small firms are doing extremely well, as if the Indian economy is growing at 10% or more, but their stock prices are languishing. How will this paradox get resolved? In my view, we may now see an outperformance by quality small-cap stocks and possibly continued stagnation in large-cap stocks.
The Indian equity markets have underperformed most global markets since the market peaked in September 2024, after an 18-month bull run. During this run, the bulls refused to be reined in even by the underwhelming performance of the ruling party in the June 2024 general elections. After a day of shock at the results, markets resumed their upward march—until headwinds started emerging later in 2024, followed by an 18-month phase of underperformance. However, if you look at the large companies in the NIFTY or CNX 500, this underperformance may not be obvious. While the NIFTY was down by 2% between early-September 2024 and late-January 2026, the CNX 500 was down 5%. But over the same period, the Nifty Microcap index was down 17%. The median returns were far worse.
Some of the decline in small-caps was justified. Many of them had become too expensive, carrying very high growth expectations aided by strong fund flows. So when the economic headwinds started blowing in 2025, expensive growth stocks were sold off. These headwinds came from three sources. First, reduced government capex (capital expenditure)—the principal driver of the 2023–24 bull market—which was initially blamed on the 2024 elections, but continued well into the following year. Second, India was hit with punitive tariffs by the US in 2025. Third, there was a slowdown in domestic consumption due to high taxes and slow wage growth.
Spooked by this barrage of negative news, foreign institutional investors (FIIs) sold heavily. Net outflow was nearly US$23bn (billion) across 2025 and January 2026 combined. The problem during such phases of selling is that investors tend to be indiscriminate; good stocks get punished along with the bad ones. Coinciding with continuous FII selling, the Reserve Bank of India (RBI) allowed the rupee to weaken, possibly to support exporters. Since Indian equity markets have been highly correlated with the value of the rupee, this made matters worse. Last year turned out to be the worst performance for the Indian market in over three decades; it underperformed other emerging markets by nearly 40%. In such a situation 'buyer’s strike' sets in, making markets brittle. So the market can fall sharply for no clear reason, as we saw last Thursday, when the Sensex dropped 1,400 points.
Is there a silver lining to any of this? There is. The December quarter has given us data that is suddenly very positive. Continuing with the paradoxical price behaviour of large-cap stocks (resilient) and small-cap stocks (wilting), we have just witnessed another weak quarter for Nifty 50 stocks and an excellent quarter for Nifty small-cap and micro-cap stocks. Sales of the Nifty 50 companies, which include mega-cap firms, were up 10%, but they recorded 0% operating profit growth and only 1% net profit growth. The broader CNX 500 companies recorded 11% sales growth and 8% growth each in operating profit and net profit, similar to BSE 250 large- and mid-cap stocks (11% sales growth and 7% profit growth).
However, contrary to conventional wisdom—which assumes that smaller companies do worse under economic stress because they have less resources than large companies to withstand headwinds—smaller companies have done very well. Sales growth of the Nifty Microcap index was 12%, operating profit growth was 13% and net profit growth was 24%. The best-performing group was the Nifty Smallcap 250 which recorded sales growth of 11%, strong operating profit growth of 22% and a stunning net profit growth of 38%, thanks to triple-digit profit growth in many companies such as Mangalore Refinery, Chennai Petroleum, Craftsman Automation, Force Motors, MCX, Ramco Cement, Engineers India, Laurus Labs, JK Tyres, Navin Flourine, Aarti Industries and others.
I do not know whether this will lead to a new bull market, especially in small-cap stocks, but we are probably in a situation opposite to the one we were in, in September 2024. Valuations are now very reasonable for many small but fast-growing companies. Their fundamentals have improved, as mentioned above. Of the 1,000 companies we track, about 200 have reported operating profit growth of 30% which is the highest number since the June quarter of 2023.
There are also a few economic indicators that support this view. Government capex has got up and there is some pickup in private-sector capex as well, if we go by corporate data. The commercial vehicle segment is doing very well; e-way bills have hit new highs; and bank credit growth remains strong. Improving fundamentals of quality small-caps combined with falling stock prices make for an interesting combination.
Fiercely independent and pro-consumer information on personal finance.
1-year online access to the magazine articles published during the subscription period.
Access is given for all articles published during the week (starting Monday) your subscription starts. For example, if you subscribe on Wednesday, you will have access to articles uploaded from Monday of that week.
This means access to other articles (outside the subscription period) are not included.
Articles outside the subscription period can be bought separately for a small price per article.
Fiercely independent and pro-consumer information on personal finance.
30-day online access to the magazine articles published during the subscription period.
Access is given for all articles published during the week (starting Monday) your subscription starts. For example, if you subscribe on Wednesday, you will have access to articles uploaded from Monday of that week.
This means access to other articles (outside the subscription period) are not included.
Articles outside the subscription period can be bought separately for a small price per article.
Fiercely independent and pro-consumer information on personal finance.
Complete access to Moneylife archives since inception ( till the date of your subscription )
