Indian Smallcap Stocks Continue to Slide, Entering Bear Market Territory
A prolonged selloff in Indian stocks shows no signs of abating, with small-cap stocks plunging by 20% from their September peak. The NSE Nifty Smallcap 250 Index is poised to enter a bear market, having lost 3.5% on Tuesday, following a similar drop on Monday.
The NSE India Volatility Index (VIX), a measure of market fear, hit its highest level since August on Monday. Concerns over an economic slowdown and earnings growth have prompted foreign funds to exit the Indian market in recent months.
Small- and mid-cap stocks have been particularly hard-hit due to their high valuations and risk-off sentiment. Overseas investors have withdrawn over $19 billion from India since the end of September, with $7 billion of outflows occurring in January alone.
"Retail investors are in a panic mode," said Vikas Gupta, chief investment strategist at OmniScience Capital. He noted that individual investors tend to invest in small-cap firms that have historically provided strong returns, but their valuations and growth prospects are now being questioned.
The smallcap gauge surged by over 26% in 2024, following a 48% gain in 2023. However, it has plunged by more than 16% in January, on track for its biggest monthly decline since March 2020. The index is currently trading at 22 times its forward 12-month earnings, down from a peak of 26 in December.
Despite its recent struggles, India was a popular destination for global equity investors until recently, threatening to surpass China in emerging market indices. A consumption boom during the pandemic and the government's focus on infrastructure development boosted the market and corporate profits.
However, slowing demand, high inflation, and rising interest rates have weighed on the economy, with growth expected to slide to a four-year low. Corporate earnings have also begun to falter, raising doubts about the premium valuations of Indian stocks compared to their emerging market counterparts.
"This small-cap selloff, driven by excessive valuation expansion over the years, could extend the damage to the broader market," said Deven Choksey, managing director at DRChoksey FinServ Pvt. "Many investors have overexposed themselves to small stocks, and the high valuations provide no margin for error."
Meanwhile, the benchmark NSE Nifty 50 Index recovered some of its Monday losses, gaining 0.6% on Tuesday, as blue-chip stocks rebounded. Trading was thin in Asia as several regional markets, including China, South Korea, and Taiwan, were closed for Lunar New Year.