Why smallcap stocks may be up for rally after longest underperformance in 22 years

A few brokerages on Monday said the longest stretch of small-cap underperformance in 22 years appeared overdone, with the risk-reward turning attractive on the back of more reasonable valuations. They noted that small cap stocks were reeling under their longest phase of underperformance in over two decades, even though the intensity of the decline was milder than in past cycles.

In the past 20 years, there have been seven instances of calendar year returns being negative for the small cap index including 2008, 2011, 2013, 2018, 2019, 2022 and 2025. There has, however, been only one incidence of it being consecutive years (2018 and 2019). 

"Thus, odds (86 per cent probability) are in favor of small caps resuming the up move and delivering healthy double digit returns in CY26E," ICICI Direct said today.

InCred Equities said the ongoing pain feels sharper because this protracted phase has coincided with extraordinary returns in traditional Indian stores of value like gold and silver, where prices have surged 2-3 times.

"Indian small-cap stocks underperformance is “overdone”: the longest in duration in 22 years (even if not the harshest in magnitude), made psychologically worse by gold/silver FOMO—setting up a mean-reversion backdrop as uncertainty normalises and risk appetite broadens," InCred said. 

It noted that the previous small cap outperformance cycle was shorter and shallower, making the current downturn appear even more extended in contrast.

ICICI Direct said small cap's two-year forward PE premium to Nifty 50 has corrected to 4 per cent, well below its 10-year average of 11 per cent. Nifty Small Cap index now trades at 19.3 times estimated earnings per share on 2027 basis against 2025-27 estimated earnings CAGR of 20.5 per cent, thus looking i.e. attractive (less than 1 PEG) against its peers, ICICI Direct said.