With no homegrown artificial intelligence stocks to offer, India has lost out to global markets where FIIs have been redeploying capital chasing AI-driven returns, while the unresolved US-Iran conflict has kept crude above $100 per barrel, stoking inflation and deepening fiscal anxieties. Yet none of it has been enough to stop the rally in smaller stocks.The turnaround in market breadth has been striking. Of the 3,343 BSE-listed companies trading below Rs 10,000 crore in market capitalisation, only 398, or 12 percent, were in positive territory between January and March 2026. Since April, nearly 2,358 companies, or 70 percent of the total, have delivered positive returns. Among the gainers, 59 stocks surged between 100 percent and 200 percent, 361 rose between 50 percent and 100 percent, 924 gained between 25 percent and 50 percent, and 1,497 delivered returns between 1 percent and 25 percent. Only around 50 stocks remained flat, while 452 continued to trade in negative territory.
Index-level data captures the divergence in sharper relief. The Sensex and Nifty each fell 15 percent between January and March, the BSE MidCap 150 lost 13 percent, and the BSE SmallCap 250 and BSE Microcap each shed 15 percent. Since April, the Sensex and Nifty have recovered just 4 percent, while the BSE MidCap 150 has jumped 14 percent, the BSE SmallCap 250 has surged 20 percent, and the BSE Microcap has gained 23 percent.Earnings have provided the fundamental underpinning for the move. According to ACE Equities data, aggregate net profit of these 2,358 companies jumped 76 percent year-on-year in the March 2026 quarter, the strongest growth in 15 quarters. On a sequential basis, net profit rose 23 percent, the highest in eight quarters. Operating profit climbed 17 percent year-on-year, the strongest in 10 quarters, while the quarter-on-quarter increase of 13 percent was the highest in 21 quarters. Revenues expanded in double digits for the seventh consecutive quarter.The rally is not purely liquidity-driven, according to Siddhartha Khemka, Head of Research at Motilal Oswal Financial Services. He attributed the sharp improvement in market breadth since April to a combination of valuation comfort, improving earnings delivery, and a revival in risk appetite. "Following the correction during January-March 2026, valuations across the broader market became significantly more attractive, particularly in small and midcaps," he said. Khemka noted that the strong earnings were led by sectors including banking and financial services, metals, oil marketing companies, telecom, and automobiles.A similar recovery unfolded among companies with market capitalisation between Rs 10,000 crore and Rs 20,000 crore. Of the 181 firms in this bracket, only 38, or 21 percent, had posted positive returns during January-March. Since April, 160 stocks, or 84 percent of the segment, have moved into positive territory. Two stocks more than doubled, 13 gained between 50 percent and 100 percent, 35 advanced between 25 percent and 50 percent, and 110 delivered returns between 1 percent and 25 percent, leaving only 21 in the red.
Earnings in this segment, however, told a different story. Aggregate net profit declined 30 percent year-on-year in the March quarter, the steepest drop since available data begins in December 2019, and fell for a second consecutive quarter on a sequential basis. Operating profit rose just 7 percent year-on-year, the slowest pace in five quarters, while revenue growth of 13 percent was the weakest in three quarters.Independent research analyst Ajay Bodke pointed to the earnings divergence as a key driver of the rally in smaller stocks. "If you look at the divergence in earnings growth for the March quarter between small-cap and large-cap, it is quite visibly large," he said, adding that valuations in smaller stocks had been beaten down sharply and the rally was compensating for that erosion in market capitalisation.The recovery has been notably more restrained among large-cap companies with market capitalisation above Rs 20,000 crore. Of the 316 such BSE-listed firms, only 60 were in positive territory between January and March. Since April, the number of gainers has risen to 164, with 11 stocks climbing between 50 percent and 100 percent, 53 gaining between 25 percent and 50 percent, and 100 advancing between 10 percent and 25 percent. The remaining 152 either posted single-digit gains or stayed in negative territory.
Large-cap earnings have also trailed smaller peers. Aggregate net profit for the March quarter rose 13.9 percent year-on-year, while both revenue and operating profit grew 12 percent each. Among Nifty 50 companies, net profit grew just 4 percent year-on-year, marking the eighth consecutive quarter of single-digit earnings growth and the first such streak since the pandemic. Revenue rose 12 percent, while operating profit increased 4 percent.Bodke pointed to the pattern of foreign selling as a structural reason behind large caps lagging. FIIs have been consistently offloading shares over the last three years, with the bulk of the selling concentrated in mega-cap and large-cap names. "Typically, you sell what you own," he said, noting that FII portfolios are heavily weighted toward frontline names such as Infosys, TCS, HDFC Bank, ICICI Bank, and Bharti Airtel. Domestic institutional investors, mutual funds, high-net-worth individuals, and retail investors, by contrast, have provided steady support to mid and small-cap stocks, absorbing much of the foreign selling pressure.Yet sustaining the rally from here will require continued earnings support. Despite the strong results, forward earnings revisions remain relatively muted. The FY27 earnings upgrade-to-downgrade ratio stood at just 0.9x, with 103 companies upgraded and 110 downgraded, and aggregate FY27 earnings estimates for the Motilal Oswal universe were trimmed by 1.3 percent. "Some pockets are beginning to exhibit signs of excessive optimism where stock prices have risen much faster than earnings expectations," Khemka said. "The next phase of returns is likely to be far more selective and earnings-driven rather than liquidity-driven."Navneet Munot, MD and CEO of HDFC AMC, echoed the caution. "In this segment, dispersion between winners and losers can be significant, making business fundamentals, earnings quality, governance standards, and valuations far more important than market sentiment," he said. "A disciplined and diversified approach remains the most prudent way to participate in this opportunity set."The macro backdrop poses additional challenges. Crude oil and commodity prices have moved higher amid geopolitical tensions in West Asia, which could keep inflationary pressures elevated. The monsoon outlook is relatively weaker than initially expected, potentially limiting a rural demand recovery. Private capital expenditure is showing early signs of improvement but investment activity continues to be largely supported by government spending, which itself faces pressure from a higher import bill and fiscal constraints. FY27 earnings expectations, however, remain strongest in the broader market, with the Motilal Oswal universe projecting 16 percent earnings growth for mid-caps and 30 percent for small-caps, compared with 8 percent for large-caps.Looking ahead, Bodke said the performance gap between large caps and smaller peers could begin to narrow if geopolitical conditions ease. A resolution to the Iran conflict, a permanent ceasefire, or a cooling in oil prices could reduce selling pressure on large caps and draw foreign flows back into India. Any moderation in the AI-driven global
rally could also redirect capital toward Indian equities, benefiting large caps and narrowing the divergence.
Article by Ravidra Sonavane,
Source: Money control, Network18
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