Smallcap stocks were among the biggest winners of the post-pandemic bull market. The smallcap index delivered returns of 47.5% in 2023 and 29.3% in 2024, driven by strong domestic liquidity, rising retail participation and optimism around India’s long-term growth story.
That momentum has reversed sharply in 2025. The smallcap index fell nearly 10% last year, making it the worst year for the segment since 2018. Even in January, over half of the smallcap universe corrected over 20%. Many smallcap stocks are still trading 25% to 50% below their peaks.
Why the India-US trade deal has changed the mood
Sentiment shifted sharply on Tuesday after India and the US finalised a trade deal that reduced reciprocal tariffs on Indian exports from 25% to 18% and fully withdrew an additional punitive levy linked to Indo-Russian oil trade. Broader indices such as the Nifty Midcap 100 and Smallcap 100 jumped nearly 3% each in a single session. Export-facing sectors saw strong buying, reflecting expectations of better earnings visibility and improved competitiveness in the US market.
India’s tariff rate is now lower than several competing Asian exporters. Countries such as Bangladesh, Sri Lanka, Taiwan and Vietnam face tariffs of around 20%, while Indonesia, Malaysia, Thailand and the Philippines face tariffs close to 19%. This relative advantage is seen as a meaningful positive for Indian exporters.
Veteran investor Ashish Kacholia said the trade deal could mark the end of the smallcap bear phase, calling it a turning point after months of relentless selling pressure.
Relief rally or start of a new cycle?
Despite the sharp bounce, analysts caution against assuming that the trade deal automatically translates into a broad-based smallcap rally. Ravi Singh, Chief Research Officer at Master Capital Services, says the trade deal should be viewed as a supportive tailwind rather than a trigger for an indiscriminate surge across the smallcap universe.
“Smallcap companies operate with narrow product lines or concentrated business models. For such firms, the benefits of lower tariffs will be meaningful only if they have direct exposure to export-linked sectors,” he said, while adding the current market phase is very different from the liquidity-driven rallies of the past.
“Earnings quality, cash flows and balance sheet strength are now back in focus. Investors expecting the kind of across-the-board momentum seen in earlier cycles may be disappointed.”
Export-oriented smallcaps stand out
Where the trade deal could make a real difference is in export-heavy smallcap companies. Sectors such as pharmaceuticals, textiles, IT services, engineering goods and auto ancillaries are seen as the most direct beneficiaries.
Lower tariff barriers improve price competitiveness in the US market and reduce uncertainty around order flows. For small companies operating on thin margins, even modest improvements in export pricing or volumes can have an outsized impact on profitability.
Kush Gupta of SKG Investment & Advisory says the deal has improved the risk-reward equation for export-oriented smallcaps. He notes that the announcement has already sparked a sentiment shift, with smallcap indices posting their best single-day gains in months.
However, there are structural challenges. Valuations remain elevated in parts of the smallcap space. As of late 2025, the segment was trading at close to 30 times forward earnings, while expected earnings growth was only around 11%. A large number of smallcap companies have also underperformed earnings expectations in recent quarters.
“The trade deal is unlikely to fix these issues overnight. It should be seen as a sentiment booster and a sector-specific opportunity rather than a cure-all for the entire segment,” said Gupta.
Are valuations finally becoming attractive?
One positive emerging from the correction is that valuations for several quality smallcap stocks have cooled. Analysts estimate that over a third of the smallcap universe, representing nearly Rs 16 lakh crore in market cap, is now trading at fair or even undervalued levels.
Arjun Guha Thakurta of Anand Rathi Wealth says the recent correction has created a disconnect between stock prices and business performance. While many smallcap stocks have fallen sharply, earnings growth in the segment has remained reasonably healthy.
He notes that much of the selling pressure was driven by sentiment, foreign outflows and risk aversion rather than a collapse in fundamentals. With foreign investors having largely exited speculative positions, the supply overhang appears to be easing.
“When weak hands have already sold, even modest improvements in confidence can lead to sharp recoveries, especially in segments that have underperformed for extended periods,” he said.
How should investors approach smallcaps now?
Most analysts agree that this is not the time for blind index-level bets on smallcaps. The consensus view is that investors should adopt a selective, bottom-up approach rather than chasing momentum. A phased allocation strategy is widely recommended. Instead of deploying large sums at once, investors can gradually increase exposure, focusing on companies with strong balance sheets, sustainable cash flows and clear earnings visibility.
Risk management remains critical. Smallcaps are inherently volatile, and while the trade deal reduces external uncertainty, it does not eliminate company-specific risks or broader market swings. Analysts suggest limiting smallcap exposure to a level aligned with one’s risk appetite and investment horizon.
Arunagiri of TrustLine Holdings says the recovery in small and midcaps is likely to unfold over time rather than in a straight line. He believes the current phase offers opportunities for stock-specific alpha but warns against expecting a rapid return to the speculative excesses of the past.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)