Small-caps still overvalued, but opportunities for select stocks emerging, says Puneet Sharma of Whitespace Alpha | Stock Market News

Indian markets experienced a volatile January, oscillating sharply amid a blend of global and domestic uncertainties that kept investors cautious. While frontline indices regained strength over the last couple of trading sessions, they ended January with a drop of over 0.5%, marking the fourth consecutive month of losses for the Nifty 50 and Sensex. This was the first time in the last 23 years that frontline indices ended in the red for four consecutive months. 

Mid- and small-cap stocks took a severe beating during the month, with the Nifty Small Cap 100 index tumbling 10%, marking the biggest monthly drop since February 2022. 

Amid the uncertainty surrounding the Indian market and small-cap stocks, Puneet Sharma, CEO and Fund Manager at Whitespace Alpha, shares his insights on the market outlook and discusses how Foreign Portfolio Investments (FPIs) and US President Donald Trump’s economic policies could impact the Indian markets in the coming months. Edited excerpts:

Indian stocks are reeling under significant pressure compared to their Asian counterparts in January. Do you think the modest December quarter earnings have been the primary catalyst behind this sell-off?

Indian equities have started 2025 on shaky ground, underperforming their Asian counterparts amid a broader risk-off sentiment. While modest Q3 earnings have failed to impress, they are not the primary driver of this sell-off. The downturn is being fueled by foreign institutional investor (FII) outflows, rising US bond yields, stretched valuations in small and mid-caps and concerns over global liquidity tightening.

With the US 10-year Treasury yield climbing above 4.5% and a stronger dollar, FIIs have been pulling money from emerging markets like India, preferring safer assets.

Compared to other Asian peers like China and South Korea, where valuations are more attractive, India appears relatively expensive, driving reallocation. Additionally, India’s high valuations—particularly in mid- and small-cap stocks—have triggered profit booking, exacerbating the market correction. The upcoming Union Budget on Feb 1st also adds to investor caution, as they await clarity on fiscal measures and government spending priorities.

How is the recent trend of foreign institutional investor (FII) selling in India being influenced by global liquidity shifts, and what role do rising US bond yields and the Federal Reserve’s delayed rate cuts play in this trend?

The recent FII selling trend in India is being influenced by a combination of global liquidity shifts, domestic valuation concerns, and sectoral rotations driven by risk appetite changes. One of the biggest drivers is the tightening of global liquidity, with the US 10-year bond yield above 4.5% and the Federal Reserve delaying rate cuts into late 2025 due to persistent inflation.

A stronger US dollar (DXY > 106) has made emerging markets like India less attractive in the short term, prompting FIIs to rebalance their portfolios.

Additionally, China’s stock market recovery in 2025 has lured some FIIs back, given that Chinese equities are trading at significantly lower valuations compared to India. Domestically, the sharp rally in mid and small-caps throughout 2024 led to overheated valuations, prompting profit booking by FIIs who now prefer large-cap defensives over speculative plays.

Trump’s emphasis on America-first policies and rising protectionism poses risks to global supply chains. How might these disruptions impact emerging markets like India, and what sectors within the Indian economy are most vulnerable to such policy shifts?

Uncertainty surrounding President Donald Trump’s economic policies has cast a long shadow over global markets, and volatility is unlikely to subside anytime soon with Trump doubling down on America-first trade policies, tariff threats, and tax reforms. Rising protectionism, particularly in sectors like technology, manufacturing, and energy, could disrupt global supply chains, keeping emerging markets like India on edge.

Additionally, Trump’s aggressive fiscal stance—favouring tax cuts and heavy infrastructure spending—could fuel inflation, delaying potential Fed rate cuts and keeping US bond yields elevated, further tightening global liquidity.

The strengthening US dollar (DXY > 106) and risk-off sentiment have already triggered FII outflows from India, reinforcing market fragility. However, one silver lining could be that India remains a favoured long-term growth story, and with the RBI potentially considering rate cuts in the latter half of 2025, domestic liquidity may offer some cushion. But until US economic policies stabilize and global interest rate clarity emerges, volatility is here to stay for a while.

With small-cap stocks witnessing sharp corrections from their September peaks, do you think valuations have now become reasonable, or do they still appear elevated?

Small-cap stocks have witnessed a sharp correction from their September 2024 peaks, but the valuation debate remains nuanced. While prices have come down, many stocks still trade above their historical averages, making it difficult to call them outright cheap. The exuberance seen in 2023 and early 2024, driven by relentless retail and mutual fund inflows, had pushed small-cap valuations into overheated territory.

Even after the 15-30% pullback, certain pockets still appear expensive when compared to long-term earnings potential. Additionally, with global liquidity tightening and FIIs rotating funds out of mid and small-caps into large-caps, a full-fledged valuation reset may still be unfolding. Adding to the complexity, small-caps tend to experience exaggerated price movements in times of uncertainty, meaning that heightened market volatility in 2025 could magnify both downside corrections and upside recoveries.

That said, this correction has opened up selective opportunities. Companies with strong balance sheets, improving earnings visibility, and sectoral tailwinds are now emerging as attractive long-term bets. While a broad-based re-rating may still take time, investors with a stock-specific approach, rather than chasing momentum, are likely to find value in this recalibrated small-cap landscape. However, volatility will remain high, and investors should be prepared for amplified swings as market sentiment fluctuates.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.