Despite Snapping a 5-Day Slide, Smallcaps Are Still Expected to Underperform — 4 Factors Why

Smallcap Index Ends Five-Day Slide, but Analysts Say Underperformance Will Continue

The smallcap index finally reversed its five-session losing streak on November 25, offering brief relief to investors after days of persistent selling. Several smallcap stocks rebounded during mid-day trade, helping the Nifty Smallcap 100 inch into the green at 17,712.65. Top gainers included HSCL, Anant Raj, Aditya Birla Real Estate and Hindustan Copper, each rising up to 5 percent.

However, despite the short-lived recovery, analysts caution that smallcap stocks may continue to underperform in the near term. Weak earnings trends, heavy IPO activity, capital outflows and external macro pressures continue to weigh heavily on the segment. Many market experts believe that volatility is far from over and that selective stock picking will be crucial until broader market conditions improve.

Below are the four key reasons analysts believe the smallcap segment may see more correction ahead.

Weak Earnings Drag Down Smallcap Sentiment

One of the major factors behind the recent underperformance of smallcap stocks is the weak earnings performance reported during the Q2 FY26 season. According to Charmi Shah, Business Head at Wealth1, nearly 32% of smallcap companies missed earnings expectations, much higher than midcaps at 27% and largecaps at 26%.

Abhinav Tiwari, Research Analyst at Bonanza, noted that while some smallcaps posted profit growth, the overall earnings trajectory remains subdued, especially when valuations are already stretched. “Smallcaps have underperformed because valuations are high while earnings momentum has weakened,” he said.

With investors becoming increasingly earnings-sensitive, this higher rate of revenue and profit misses has added to the cautious sentiment in the smallcap index, making it vulnerable to further correction.

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Capital Outflows Intensify Pressure on Smallcap Stocks

A major trend worrying analysts is the continuous shift of investor capital from smallcaps to largecaps, driven by global uncertainty and rising risk aversion. Largecap stocks are currently viewed as safer investment avenues, especially amid volatile macro conditions.

Tiwari pointed out that Foreign Institutional Investors (FIIs) have significantly reduced exposure to riskier emerging market assets, leading to notable outflows. This shift has hurt small companies the most. “FIIs cutting exposure has added pressure. Largecaps are attracting safe-haven flows, leaving smallcaps exposed to liquidity shocks,” he said.

Siddharth Maurya, Founder & Managing Director at Vibhavangal Anukulakara, added that smaller firms are generally more sensitive to liquidity and global macro shocks, further amplifying their weakness when outflows accelerate.

Heavy IPO Activity Pulls Liquidity Away from Smallcaps

The ongoing IPO boom has emerged as another major headwind for the smallcap segment. A significant portion of market liquidity has been diverted into the primary market, leaving fewer funds for existing smallcap stocks.

Shah noted that the large influx of IPOs has constrained investor funds and triggered selling pressure in listed smallcaps. Tiwari echoed this view, explaining that liquidity has also weakened due to lock-in periods ending and a visible decline in retail investor interest.

Shravan Shetty from Primus Partners added that with money moving towards fresh IPOs, the pool available to balance FII outflows is shrinking. “The movement away from riskier emerging markets has especially impacted smallcaps, which carry higher risk,” he said.

External Shocks and Currency Volatility Hurt Margins

Smallcap companies, often operating with thinner buffers, have been more vulnerable to external shocks including US tariffs, global demand softness, and a sharply weakening rupee.

The Indian rupee recently hit a record low of ₹89.49 against the US dollar, deepening cost pressures for import-dependent sectors. Although the rupee recovered slightly after support from the Reserve Bank of India (RBI), the volatility continues to weigh on sentiment.

Shetty highlighted that smallcaps have seen higher margin compression than mid and largecaps as they struggle to absorb global shocks and currency fluctuations. This has further contributed to underperformance in the smallcap index.

What’s Next for Smallcap Investors? Analysts Expect More Volatility

Despite the short-term bounce, analysts believe that near-term volatility is unavoidable for smallcaps. Clear bottoming signals are still absent, and earnings are yet to stabilize meaningfully.

Tiwari said that while selective strong companies may do well once liquidity improves, smallcaps may continue to lag broader markets in the coming weeks. He added that stock-specific selection would remain critical.

Maurya agrees that the correction may pave the way for more sustainable, quality-driven smallcap investing. “Long-term investors should focus on stabilization of earnings, FII sentiment, and liquidity flows before re-entering aggressively,” he said.

Shah further advised investors to adopt a selective and diversified approach, prioritizing companies with strong balance sheets and consistent growth patterns. She expects stabilization and a potential recovery as liquidity improves and economic indicators strengthen into FY26, especially with expected rate cuts.

However, Shetty concluded that unless the Union Budget 2026 brings supportive measures to counter the ongoing pressures, smallcaps may continue to underperform the broader market indices.

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