The continued underperformance of midcap and smallcap stocks is largely driven by panic selling, particularly among investors who entered the market during COVID and have not experienced this kind of correction before. The market has underperformed over the past two years, and since January, investors have seen a nearly 15 per cent correction in the Nifty. While midcap and smallcap stocks continued to rise after March, even as the Nifty declined, September marked a sharp correction, with the pressure extending into October.
Divergence Between Largecaps and Broader Markets
While the Nifty recovered to near-flat returns in October after falling around 6 per cent in September, midcaps and smallcaps continued to face pressure, declining 5 per cent and 7 per cent, respectively, in October. As highlighted, midcaps are down 12 per cent and smallcaps 10 per cent over the past two months.
Valuations and Earnings Expectations
The selling pressure is also visible in recent index movements, with the Nifty Midcap 150 down 10.2 per cent from its August 31 high and the Nifty Smallcap 250 down 8 per cent from its September 8 high. Midcaps were trading at a 42 per cent premium to the Nifty, compared with their five-year average of 40 per cent, while smallcaps were trading at a 45 per cent premium, against their five-year average of 75 per cent.ย
According to Swapnil Aggarwal, Director, VSRK Capital, earnings growth expectations for the midcap and smallcap universe have been pegged at 16โ20 per cent, making earnings delivery key to sustaining returns.
Margin Call Pressures Accelerate Sell-off
According to experts, another key factor driving the sell-off is margin trading, or MTF positions.ย
“Investors facing margin calls are being forced to cut their positions. Consequently, they are selling stocks where they see relatively lower losses, limited downside or some profits to book, adding to the pressure. This selling, combined with panic among newer investors, has intensified the correction,” Aggarwal said.
“I would not call this a healthy correction. However, it has served as a reminder that making money in midcap, smallcap, or any stocks is not as easy as it may appear,” he added.
Outlook: Margin Pressures to Weigh on Q3
On the outlook, while second-quarter results have been good, experts expect more pain in the third quarter due to rising raw material prices, crude oil, and other costs. These pressures could weigh on earnings and market sentiment.
Impact of Foreign Institutional Investors
Foreign institutional investors are also selling, but experts do not see FII selling as the primary driver of the correction in midcap and smallcap stocks, as their allocation to these segments is limited. The selling pressure in largecaps is also weighing on the broader market.
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(This article is for informational purposes only and should not be construed as investment, financial, or other advice.)