December 2025 / Q3 FY26

Headline Indices Are Hiding the True Extent of the Correction

While portfolio-level drawdowns may appear sharper than headline indices such as the BSE 500 or Nifty Smallcap 100, these indices significantly understate the depth of correction across the broader market, particularly in lower market-cap segments.

The BSE 500, our formal benchmark, captures only the largest 500 companies by market capitalisation and is structurally misaligned with our strategy:

This divergence reflects a risk-off environment, where liquidity concentrates in a narrow set of large, institutionally owned names, while the broader universe experiences sharp drawdowns.

Extent of Price Corrections by Market Capitalisation

Key observations:

Understanding the Divergence from the Nifty Smallcap 100

Given the depth of correction across the broader small and micro-cap universe, a natural question is why this stress is not fully reflected in headline indices like the Nifty Smallcap 100.

One key reason for Equitree’s relative underperformance during this phase — including versus the Nifty Smallcap 100 — has been the concentration of investor flows.

Despite the market peaking in December 2024, monthly mutual fund inflows into small-cap schemes have grown by 30–40%, largely driven by SIPs. These flows, however, have been concentrated in a narrow subset of larger, more liquid, and widely researched small-cap stocks, which construct majority of the index. In parallel, rising flows into flexi-cap schemes have further supported these same names, providing buoyancy to headline indices.

Mutual Fund Inflows

As a result, index-level drawdowns have remained relatively contained (~10–12%) whereas the broader market universe has seen a materially deeper correction, as reflected in the data above.

To put this in perspective:

Equitree operates in an institutionally under-owned segment of the market, typically companies with ₹1,000–5,000 crore market capitalisation, which are too small for meaningful mutual fund participation and largely uncovered by sell-side research. As a result, price volatility during risk-off phases is driven more by liquidity swings than by changes in business fundamentals.

Historically, this segment has offered the strongest scope for alpha. As sentiment improves and liquidity broadens beyond index-heavy names, under-owned companies with solid fundamentals tend to benefit from earnings-led re-rating and wider investor interest, creating a discovery premium.

Market Outlook: Where Do We Go From Here?

Markets are ultimately driven by a combination of growth, valuations, and liquidity. We start with growth, where early signs of improvement are visible.

1. Growth

Earnings momentum is showing clear signs of recovery. H1FY26 delivered double-digit year-on-year earnings growth across market segments — 13% for large caps, 17% for mid caps, and 16% for small and micro caps (median PAT growth, ex-BFSI) — reflecting a meaningful rebound from last year’s slowdown.

Management commentary and industry feedback suggest that Q3 and H2FY26 should see sustained, or potentially improved, earnings performance, supported by operating leverage and steady execution of capex. Overall, the outlook for earnings growth remains constructive.

Recent macroeconomic data reinforces this trend. December IIP growth accelerated to 7.8% YoY, led by manufacturing, mining, and a rebound in electricity output. This points to sustained industrial activity and improving demand conditions. If these trends persist, earnings growth is likely to become a supportive driver for markets over the coming quarters.

2. Valuation

Valuations have corrected meaningfully through a combination of price correction and earnings catch-up. This has brought markets closer to long-term averages, particularly in the small and mid cap segments, where excesses were most pronounced.

When the correction began in September 2024, markets were trading at 30%+ premiums to their 10-year median valuations. The subsequent correction was largely valuation-led, with several stocks that were priced for perfection correcting 35–50%.

As a result, valuation premiums have compressed sharply. Today, most market segments are trading at 5–10% premiums to long-term averages, while micro-caps are close to historical valuation levels. In the context of India’s structural growth profile, these valuation levels are not uncomfortable.

When markets trade at or near long-term average valuations, future returns tend to be driven more by earnings growth than by multiple expansion. In such phases, returns are typically reasonable, while downside risk is meaningfully lower.

However, aggregate market valuations can mask significant dispersion beneath the surface. Even as headline valuation metrics normalise, valuation spreads remain wide — with some pockets of the market still trading at elevated multiples, while others are available at meaningful discounts to their own 10-year averages.

Historically, the best outcomes in such environments have come from a bottom-up approach, where capital is allocated selectively to businesses with strong fundamentals but attractive valuations. When growth sustains, these opportunities have often delivered superior forward returns, well above market averages.

3. Liquidity

Liquidity conditions remain supportive, driven by a structural shift in domestic savings toward financial assets. Sustained growth in SIP inflows highlights the durability of this trend.

Importantly, each year has established a higher base of inflows, indicating persistence rather than sentiment-driven behaviour. Monthly SIP inflows have increased steadily from approximately ₹12,000 crore in FY23 to ~₹31,000 crore in FY26 YTD, with December 2025 marking the highest monthly SIP inflow on record at ₹31,002 crore.

Equity and mutual funds now account for ~15–16% of Indian household financial savings, up meaningfully from high single-digit levels a decade ago. This reflects increasing financialisation, broader participation, and growing comfort with market-linked instruments.

SIP flows are sticky, predictable, and long-term in nature. They provide a steady source of domestic liquidity, reduce reliance on foreign capital, and help absorb volatility during market corrections.

We expect this structural liquidity support to remain a key stabilising factor for markets over the medium term.

Tenure of the Correction: Where Are We in the Cycle?

Historically, corrections in the Nifty Smallcap 100 have been time-bound. Over the past two decades, no major correction has lasted beyond ~20 months, with the longest phase occurring between January 2018 and August 2019. That period was driven by an unusual confluence of factors, including the credit squeeze, RBI-led banking sector clean-up, implementation of LTCG, and the IL&FS crisis.

The current correction, which began in December 2024, is now approximately 13 months old. Historically, index-level corrections in the small-cap segment have typically lasted 12–15 months, suggesting that we are likely in the later stages of the correction cycle.

Historical Corrections in the Nifty Smallcap 100

History shows that market recoveries after major corrections tend to be swift and meaningful. Data indicates that 6-month returns from correction lows have often been in the 40–60% range as confidence returns.

While near-term volatility cannot be ruled out, particularly given ongoing geopolitical developments and global uncertainty, there is no evidence of stress in underlying business fundamentals. Demand trends remain intact, earnings visibility is stable, and on-ground commentary, supported by macro indicators, continues to point toward growth.

Importance of Staggered Investing in Small and Micro Caps

What Are We Doing?

In phases like the current one, market prices tend to become noisy, while underlying business fundamentals matter more than ever. Our focus during this period has therefore been on going deeper into each portfolio company — retesting growth assumptions, stress-testing balance sheets, and reassessing long-term earnings visibility.

This is not the first time we have seen stock prices correct meaningfully even as businesses continue to execute well operationally. Based on extensive discussions with management teams and industry participants, business visibility across the portfolio remains intact.

Key growth drivers are summarised below:

Equitree PMS Portfolio Update

Operating Performance

Valuations

Closing Thoughts

In our experience, periods like the current one — where earnings remain resilient but valuations have corrected — have often provided a favourable setup for medium-term compounding as sentiment normalises. The combination of healthy growth visibility, conservative balance sheets, and below-average valuations across much of the portfolio reinforces this view.

Accordingly, we see the ongoing correction as an opportunity to selectively top up existing positions and deploy incremental capital, building exposure at more attractive entry points with a 3–5 year investment horizon.

While near-term macro and geopolitical developments may continue to influence sentiment, our focus remains unchanged: owning well-managed, cash-generative businesses with durable growth potential, and allowing time and discipline to drive outcomes.

As always, we would be happy to connect and discuss further.

Sources

01

Equitree Capital internal performance records and portfolio analytics as of 31st December 2025. Returns over one year are annualised; individual portfolio performance may differ.

02

NSE; Equitree Capital research — Nifty Smallcap 100 index history and the divergence vs Equitree portfolio NAV across the December 2025 correction window.

03

Company disclosures; Ace Equity; Equitree Capital research — portfolio company sector tags, growth drivers, FY25→FY26E PAT growth, P/E and 10-year median P/E, PEG, and D/E ratios. Snapshot as of 29 January 2026.

04

Capitaline; consensus brokerage estimates; Equitree Capital research — historical small-cap correction tenures and recovery patterns referenced in the "Tenure of the Correction" section.