If you are a stock market investor betting big on small-caps, 2025 would have left you a little poorer than the previous year. While large-cap indices also endured volatility, they have hit fresh lifetime highs in recent weeks.
Small-caps, however, are still trailing—and it is no surprise. Looking at returns over the past year, the NSE Nifty 50 has gained 10 per cent. By contrast, the Nifty Smallcap 250 index declined by 6 per cent, and the Microcap 250 fell by 10 per cent.
Investors have generally been unsettled by continued geopolitical tensions, the 50 per cent import tariffs imposed by the US and tepid corporate earnings growth. This combination fuelled stock market volatility throughout the year. However, small-caps were also coming off the back of stellar returns in previous years. For instance, in 2024, the NSE Smallcap 250 index surged by 25 per cent, following a massive 46 per cent jump in 2023. This sharp outperformance caused valuations to surge well ahead of historical averages, leading to a loss of investor appetite in 2025 and a steeper correction than that seen in large-caps.
While this correction has reduced some of the ‘froth’, market experts remain cautious as they have yet to find valuation comfort. Between March 2020 and September 2024, the Nifty 250 Smallcap index rose by 500 per cent—with even sharper gains in stocks beyond the Nifty 500—while the Nifty 50 grew at just over 200 per cent, noted Nitin Jain, fund manager at UTI Management Company.
“Valuations in large-cap are in the fair value zone now; small-cap is still a bit on the expensive side. So, valuations are not cheap as such, even after this correction,” he said.
Kunal Vora, head of India Equity Research at BNP Paribas, echoed the sentiments. “We have seen euphoria in mid- and small-caps over the last five to six years. So, just looking at where they were in September 2024 and where they are right now does not make sense,” said Vora.
He pointed out that on a three-to-five-year basis, small-cap stocks had not only seen price appreciation, but their valuation multiples had also escalated—rising, for example, from 20 times to 60 times. A correction back to 40 times did not necessarily mean they had suddenly become cheap. “In any market, you will have stocks which will be reasonably valued. But, as a basket, it is not that just because they have corrected from the peak, they are screaming buys to us,” Vora said.
Where are the markets headed in 2026?
The trajectory will depend on many factors. Corporate earnings have been tepid for several quarters, though some analysts feel they may have bottomed out, suggesting a recovery could be in sight. This remains a key metric to watch, although any recovery may yet be uneven.
“We have seen several quarters of earnings downgrades after certain expectations were set following two or three very good years. We think earnings are bottoming out now. In the second quarter, we started seeing earnings upgrades in a few companies. Going forward, more companies will report stable earnings or an improving trajectory in terms of earnings growth. So, in terms of earnings, 2026 looks much better compared to 2025. The base is also much more favourable,” said Jain.
A major sentiment booster for equity markets this year would be the potential signing of a bilateral trade deal between India and the US. There have been multiple rounds of discussions, and while a deal appears close, it is yet to be finalised. Similarly, a trade deal between India and the EU is also on the horizon and is expected to be completed this year.
While India is not a major exporter, and there are no major export-dependent listed sectors that will be directly impacted, certain sectors such as gems and jewellery, fisheries and textiles have been hit hard by the US tariffs. As these sectors are labour-intensive, they have an indirect bearing on the economy and the markets.
Crucially, trade tensions have weighed on foreign institutional investors (FIIs), who have pulled out of Indian stock markets in massive volumes over the last year. Some of these outflows have been offset by strong domestic retail inflows. The completion of trade deals, especially with the US, would provide a significant boost to FII sentiment.
On the domestic front, the economy appears to be on a stable footing. Inflation has declined considerably, and GST cuts—alongside previously announced income tax relief—have helped boost consumption. The Reserve Bank of India also cut interest rates by 125 basis points as the focus shifted toward stimulating growth amid low inflation.
Gaurav Mehta, head of SIF (Equity) at SBI Mutual Fund, is also bullish on equities at the start of 2026. “On our valuation measures, which track equity valuations as a spread to government bond yields, the correction in equity indexes as well as the drop in bond yields led to valuations moving back towards historical medians. This combination led to our asset allocation framework moving to a 60 per cent equity allocation on a scale of 0–100 per cent, versus 20 per cent entering 2025, suggesting a move to a neutral versus a significant underweight stance. Going into 2026, that allocation stays unchanged,” he said. However, he also expects “leadership” to remain with large-caps, which could increase market polarisation.
“Small-cap valuations remain the most stretched across the curve, with the small/large forward price-to-earnings at 1.25 times, far above the long-term average of 0.9 times and close to previous peaks—signalling that recent performance has been dominated by multiple expansion rather than earnings delivery,” according to analysts at Equirus Securities.
They warned that small-caps remain the most vulnerable to mean reversion should earnings revisions soften or domestic flows weaken.