Retail-heavy stocks bear the brunt as market selloff deepens

Market_bears

• Mid-cap, small-cap, and SME stocks have seen sharper declines than large-caps
• Valuations remain elevated despite corrections; earnings growth is still weak
• Investors shift funds to large-caps; flows move to gold, real estate, and FDI

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Selling pressure in Indian stocks has been sharper in retail-dominated segments than in large-caps, with mid-, small-cap, and SME shares bearing the brunt of the decline.

Since the start of the year, the BSE MidCap index has fallen 5.8 percent, the SmallCap index has declined 8.1 percent, and the SME IPO index has dropped more than 10 percent, recording their steepest monthly fall in nearly 12 months. That compares with a 3.5 percent decline in the benchmark Sensex and Nifty indices.

This selling follows muted returns over the past two years, despite significant inflows into mid-cap and small-cap mutual funds that far exceeded investments in large-cap funds. Valuations rose sharply during this period even as earnings growth remained limited, leaving broader market segments vulnerable once market conditions turned less favourable.

With the macroeconomic environment weakening and geopolitical risks increasing, valuations have begun to correct, triggering widespread derating across mid-cap, small-cap and SME stocks. Analysts said the sharp run-up in prices had stretched valuations well beyond earnings support, accelerating the sell-off once growth momentum slowed.

Deepak Jasani, independent analyst, said that while stock prices have corrected, earnings growth has also weakened. He noted that a meaningful recovery would depend on an improvement in earnings visibility across large-cap, mid-cap and small-cap companies. Until earnings growth strengthens, earnings-per-share expansion is expected to remain muted, limiting the scope for valuation re-rating.

Market participants said investor rotation has further intensified the decline. As quality stocks in larger companies became available at more reasonable valuations, investors exited SME, small-cap and mid-cap stocks and shifted funds toward larger mid-caps and large-cap names. SMEs, which had earlier commanded premium valuations due to strong earnings growth, saw profit booking accelerate as liquidity moved toward relatively safer and more liquid segments.

Siddharth Bhamre, Head of Research at Asit C. Mehta Investment Intermediates, said the valuation gap between mid-cap and large-cap stocks had become excessively stretched and is now undergoing realignment. He added that weak index performance has increased redemption pressure, as a large portion of investor money remains concentrated in these segments.

According to Bhamre, selling by domestic mutual funds has added to the underperformance of mid-cap and small-cap stocks, a trend he expects to persist for some time. He noted that most inflows into these segments came through mutual funds and that muted returns have begun testing investor patience.

He pointed out that the Nifty has delivered no returns on a two-year SIP basis, while the three-year aggregate return stands at around 10 percent. In comparison, small-cap investments continue to remain in the negative zone, increasing the risk of further redemptions as corrections deepen.

Analysts said investors who have continued SIPs in mid-cap funds over the past three years have seen little or no capital appreciation, prompting reassessment of asset allocation. With returns scarce in equities, flows have gradually shifted toward alternative assets such as gold, select pockets of real estate and foreign direct investment, which have outperformed domestic equity markets over the same period.

Despite the recent decline, analysts cautioned that valuations in several mid-cap and small-cap stocks remain elevated. While stock-specific opportunities may exist, identifying quality companies during a falling market carries higher risk, and experts said volatility may need to subside before sustainable buying emerges.

However, some market participants believe the correction may offer selective entry opportunities. Ambreesh Baliga, independent research analyst, said the current phase does not indicate a bear market. While markets could decline slightly further, identifying an exact bottom is difficult. Given the scale of the correction, he said broader markets appear oversold at current levels.

Baliga added that retail investors with available cash may consider staggered buying during the correction, though many retail participants may not currently be holding surplus funds. On institutional activity, he said mutual funds are selectively buying as they are sitting on cash, while foreign institutional investors continue to sell. He added that FIIs typically have limited exposure to small-cap stocks, reducing their direct impact on that segment.

Analysts also noted that mutual funds have limited participation in true small-cap stocks, as they generally avoid companies with market capitalisation below Rs 5,000 crore. As a result, buying interest in the broader small-cap universe remains limited.

Experts said meaningful buying is likely to emerge from cash-rich investors, including high-net-worth individuals and portfolio management services. Once sustained accumulation begins, markets could witness a recovery, supported by valuations that have turned relatively more attractive following the recent correction.