Smallcaps, midcaps could see more pain: Ambit Capital's Nitin Bhasin

The market is halfway through its ‘concentration cycle’, which implies a prolonged sideways movement where small and midcaps (SMIDs) considerably underperform, says Nitin Bhasin, Head- Institutional Equities, Ambit Capital. In an interview to Samie Modak in Mumbai, Bhasin says valuations of SMIDs relative to largecaps are still expensive and need to converge. Edited excerpts:

 

Why is India underperforming when most emerging markets (EMs) are doing well?

 

Investors sitting outside India have a wider choice today. Earlier, India was the standout performer when other EMs were struggling. But now the cycle has turned, as India fares the worst amongst EM peers on earnings revision over the past year. Global investors are allocating to other EMs, driving down India’s valuation premium below historical averages, particularly those linked to manufacturing, commodities and hard assets.

 

Globally, why are hard assets and commodities outperforming?

 

De-dollarisation, artificial intelligence (AI)-led asset-intensive investment and onshoring of manufacturing are driving a global hard-asset cycle. 

 

Earlier, China was the single buyer. Now, multiple countries are building factories, defence capabilities and electronics supply chains, which shifts bargaining power to commodity producers. This is why metals, energy, defence and manufacturing exporters are outperforming globally — in Europe, Japan, Korea, and Taiwan.

 

Can you explain your structural market cycle framework? And where are we in that cycle today?

 

We have analysed India’s 22-year market history using a concentration–fragmentation framework. We constructed an index using the squared free-float market capitalisation of the top 500 stocks — similar to a Herfindahl-Hirschman Index. In India, bull markets typically lead to fragmentation. In the United States (US), bull markets lead to concentration because global earnings accrue to a handful of megacap companies. In September 2024, we wrote that India had entered a 30 to 36-month rising concentration cycle.

 

The fragmentation phase ended around September 2024. We are now in a concentration cycle that typically lasts around 36 months. I believe we are roughly halfway through this period. This implies a prolonged sideways market where largecaps remain relatively stagnant, while SMIDs considerably underperform.

 

Does this mean the pain in SMIDs is not over yet?

 

Correct. Historically, these concentration phases involve grinding drawdowns in SMIDs — both in price and valuations. Both earnings growth normalisation and multiple derating have driven previous corrections. While SMIDs have witnessed some moderation in the current episode, the correction so far has been shallow. Relative valuations of SMIDs typically converge back toward largecaps. 

 

Today, smallcaps trade at about 1.1x the Nifty on median price-earnings (P/E) ratio, whereas historically these cycles settle closer to 0.8x. More importantly, empirical evidence suggests muted SMID one-year forward returns at these entry multiples. Even if domestic flows soften the correction somewhat, the grind will continue. Valuations, not just prices, need to adjust.

 

Earnings expectations have also been cut repeatedly. How do you see the earnings cycle?

 

Analysts typically start the year with optimistic earnings assumptions — 18-20 per cent growth — and end closer to 9-10 per cent. 

 

Over the last three years, earnings projections were largely met, which has somewhat led to a false sense of optimism. Now we are back to cutting numbers again. For 2025-26 (FY26), nine-month earnings cuts are the highest in the last four years. The problem is not just slower growth, but also the quality of growth. Incremental FY26 earnings is concentrated within commodities, metals, and oil & gas, wherein historically, estimates have not been met. FY27 earnings recovery hinges largely upon financials (BFSI) and any sectoral headwind could derail the entire index’s earnings trajectory.

 

Which sectors are benefiting in the current environment?

 

The expensive sectors are services — consumption, discretionary. Inexpensive sectors are hard asset-linked businesses like metals, oil & gas, and commodities. That is why these sectors have outperformed in recent months. 

 

Information technology (IT) is an interesting exception. Despite weak sentiment, IT has delivered around 11 per cent returns with similar earnings growth. Historically, during concentration cycles, investors gravitate toward defensives — FMCG, pharma, and IT — because they are liquid, cash-generative, and less cyclical.

 

What is your core portfolio strategy right now?

 

We are advising institutional investors to stay with largecaps and megacaps. Our model portfolio is skewed toward defensives — FMCG, healthcare, and IT. This is not a high-alpha environment. It is about capital preservation.