Amidst the uncertainties, Indian mid- and small-cap indices have delivered a standout performance in the last two months. The Nifty Smallcap 100 has surged over 20% from its March 2026 lows. The Nifty Midcap 100 has climbed nearly 15%, touching fresh highs in May 2026.
Indian equity markets’ performance has been muted in the last one month as external factors like crude and currency have raised uncertainty on domestic fiscal and corporate earnings. Despite the deep depreciation of the Indian rupee and the stock performance compared to other countries like China, India continues to demonstrate relative resilience, navigating this complex environment, which is marked by extended geopolitical tensions and inflationary concerns.
Amidst the uncertainties, Indian mid- and small-cap indices have delivered a standout performance in the last two months. The Nifty Smallcap 100 has surged over 20% from its March 2026 lows. The Nifty Midcap 100 has climbed nearly 15%, touching fresh highs in May 2026.
What’s driving mid & small-cap stocks?
This rally is being driven by three key factors: First, renewed domestic liquidity since April continues to support markets, reflecting MF and retail investors’ confidence in India’s long-term growth story. Second, structural themes such as defence indigenisation, manufacturing growth, infrastructure spending, and digitalisation continue to create a multi-year opportunity for emerging businesses. Third, valuations in the mid and small cap space had corrected significantly during FY26, making many stocks attractive ahead of the recent recovery. And lastly, good quarterly results.
In Q4FY26, the broader market earnings grew better than consensus estimates. The full impact of GST rationalisation was played out during the quarter and supported consumer discretionary, durable, and staple earnings growth. However, considering the uncertainty in earnings revival in Q1FY27 and the current premium valuation, there is room for near-term consolidation in the mid & small cap space. The Nifty Midcap 100 now trades at a price-to-earnings multiple of around 26x 1yr fwd., which is marginally above its 10-year average. The Nifty Smallcap 100 is at 22x — higher than the long-period average but less stretched. For context, the Nifty 50 trades (18x) at a discount to its long-term averages, offering a more balanced risk-reward profile compared to mid- and small caps.
Diverging sectoral trends
On a year-to-date basis, the Indian equity markets have shown a clear divergence across sectors. Cyclical and growth-oriented segments such as Power, Metal, and Defence have outperformed, driven by strong government infrastructure spending, rising demand for energy, and increased focus on domestic manufacturing and Defence modernisation. Similarly, gains in Capital Goods and Energy reflected optimism around industrial growth and infrastructure spending. Defensive sectors such as Pharma and Telecom remained resilient because of consistent demand, INR depreciation and improving profitability. Nifty IT was the biggest drag, due to global IT slowdown and AI-led pricing issues. Realty underperformed amid valuation concerns, slower urban consumption, and tighter liquidity conditions. Overall, while the Nifty 50 declined (-9.3% YTD), resilience in Midcaps (+1.3% YTD) and Smallcaps (+1.1% YTD) highlighted investor preference for domestic growth stories over global-exposed large caps.
India’s macroeconomic fundamentals are significantly stronger today than during previous oil shock periods. The banking system remains well capitalised, the fiscal deficit is under control, the current account deficit is manageable, and steady SIP inflows continue to provide structural support to equities. However, with crude prices rising sharply and the rupee remaining under pressure, the RBI is expected to stay vigilant on intervention measures while closely monitoring the outlook for inflation and GDP growth.
Currently, the economy is confronting a supply-side shock, not a demand collapse. The Hormuz situation, Iran-US diplomacy, US Fed policy signals, and domestic earnings delivery will each play a defining role in shaping the second half of 2026.
For investors, the broader message is clear that India’s long-term growth story remains intact, although near-term visibility remains clouded. In this environment, a staggered and diversified investment approach appears more prudent than waiting for the perfect entry point, as markets continue to reflect cautious optimism despite lingering risks.
Meanwhile, rising bond yields and CPI inflation increase the risk of central bank rate hikes, which could weigh on equities. In the near term, domestic markets are expected to remain range-bound with a negative bias. The prevailing strategy is to buy on dips and sell on rallies. A sustained uptrend will likely require greater geopolitical stability and softer oil prices, which would help improve macro conditions and revive FII sentiment, especially as corporates enter a weak Q1FY27.
First published in Mint.
