Smallcap Stocks Lag as Nifty and Sensex Hit New Highs in 2025

A Tale of Two Markets

The Indian stock market is currently presenting a significant paradox. While benchmark indices like the Nifty 50 and BSE Sensex are consistently scaling new all-time highs, the broader market, particularly the small-cap segment, is not participating in the rally. The NIFTY Smallcap 100 index continues to trade under pressure, highlighting a clear divergence in market performance that has left many retail investors on the sidelines. This split is driven by a combination of factors, including valuation concerns, earnings growth disparities, and shifting institutional investor sentiment.

Large-Caps Lead the Charge

On December 22, 2025, the BSE Sensex surged past the 85,000 mark, and the Nifty 50 comfortably traded above 26,100. This upward momentum is fueled by several positive triggers. Renewed foreign fund inflows, optimism around a potential India-US trade deal, and strong performance in high-weightage sectors like IT and banking have provided the necessary thrust. Positive global cues, including hopes of interest rate cuts by the US Federal Reserve following soft inflation data, have further bolstered investor confidence. Domestic institutional investors (DIIs) have also been active buyers, absorbing the selling pressure from foreign portfolio investors (FPIs) and providing stability to the market.

The Struggle in the Small-Cap Space

The story is starkly different for small-cap stocks. The NIFTY Smallcap 100 index is trading nearly 10% below its previous record high of 19,716. This underperformance stems from several fundamental challenges that have made investors cautious. One of the primary concerns is lofty valuations. Even after a year of consolidation, the small-cap index continues to trade at a price-to-earnings (P/E) ratio significantly higher than its three-year median average of 28x, making it unattractive for value-conscious investors.

Weak Earnings Dampen Sentiment

Furthermore, the earnings performance of small-cap companies has failed to inspire confidence. During the September 2025 quarter (Q2FY26), the aggregate net profit growth for companies in the NIFTY Smallcap 100 index was a mere 1.5%. This pales in comparison to the 7% to 8% growth reported by companies in the NIFTY Midcap 100 and NIFTY 50 indices for the same period. This sluggish earnings growth has kept valuations elevated and has been a key factor behind the segment's underperformance.

Institutional Flows and Market Dynamics

Institutional investment trends have also contributed to the pressure on small-caps. Foreign institutional investors (FIIs) were net sellers in the Indian markets during the September quarter, with consistent selling observed in several small-cap stocks. Additionally, inflows from mutual funds into small-cap dedicated funds have slowed down in 2025. In contrast, mutual funds have been consistently increasing their stakes in mid-cap stocks, indicating a clear preference for quality and stability over the higher-risk small-cap segment.

Expert Guidance for Investors

Market experts are advising caution and a strategic shift in investment approach. Dr. VK Vijayakumar, Chief Investment Strategist at Geojit Investments Limited, noted that many retail investors, particularly those who entered the market post-2020, are holding portfolios with losses due to a focus on small-caps. He advises that to benefit from the anticipated 2026 rally, which is expected to be driven by earnings growth, investors should pivot towards large-caps and quality mid-caps that have strong growth potential and more reasonable valuations.

Key Index Performance Snapshot

To illustrate the performance gap, here is a look at how key indices have performed.

Technical Outlook and Consolidation

From a technical standpoint, the NIFTY Smallcap 100 index appears to be in a prolonged consolidation phase. After a massive rally of nearly 247% from the COVID-19 lows in March 2020 to November 2021, the index has entered a period of time correction. Such consolidation phases are common after sharp, euphoric rallies and can last for an extended period before the next breakout occurs. The current chart patterns suggest that this consolidation may continue in the short to medium term.

Conclusion: A Call for Selective Investing

The current market environment underscores the importance of a selective and fundamentally-driven investment strategy. While the headline indices paint a rosy picture, the underlying market is fragmented. Small-cap stocks are expected to remain volatile due to unpredictable earnings and high-beta characteristics. For this segment to regain momentum, a significant improvement in earnings growth is essential to justify valuations and attract renewed investor interest. Until then, investors are advised to focus on quality large-cap and mid-cap stocks with visible earnings growth and strong fundamentals.