As the year slowly draws to a close and the holiday mood sets in over the markets, the mind was thinking about how the year played out against investor expectations. At the start of the year, the market was clearly gung-ho on smaller companies outperforming larger ones.
Bottom-up stock picking was aggressive. Investors wanted to take more risks. The craze to buy smaller companies was running so high that marquee investors were hunting down SME companies to buy at the pre-IPO stage itself. Clearly, the FOMO in the market was very high at the start of the year, and the mood was inclined to take big risks. The market mood was badly tested in March when we saw a temporary phase of despondency. But, the mood swung back to confidence by June and investors once again returned to risk taking in the same themes and stocks they chased at the beginning of the year.
We have seen a significant tiring out since then. Microcaps and SMEs have seen a sharp dip in the second half of the year, leaving several portfolios heavy with them sharply in the red. As the year draws to a close, the Nifty microcap 250 index is down 15.6% off its 52-week high. The Nifty Small Cap 250 index is down 9.66% from its 52-week high. The Nifty Midcap 150 has shown relatively better resilience, falling just 1.55% from its 52-week high. The Nifty 50 has shown the most strength, staying just 1.36% off its 52-week high. In terms of calendar year returns, the Nifty 50 gave 9.36%, the Nifty Midcap 150 earned 4.23%, the Nifty Small Cap turned in a negative 8.38%, and the Nifty Microcap Index lost 11.82%.
Clearly, the headline Nifty50 numbers do not provide any indication of the damage in individual portfolios of retail investors. While it appears that the index has done decently in the calendar year, individual portfolios have struggled to varying degrees. Investors who took moderate risks have managed to restrict the drawdown in their portfolios. Meanwhile, the high-risk takers have bled their portfolios significantly.
When expectations get belied so strongly, and high conviction turns out significantly wrong in a calendar year, they run the risk of further deteriorating in the subsequent year before things improve. When investors read a year completely wrong and keep putting more money into the wrong parts of the market in the hope of a recovery in the next year, the next year can see even more testing times. That is the risk we run for 2026 in Indian equities.
We could see things get far worse in the weak parts of the market before they get better. If this happens, the monies which flowed in through the year on expectations of a recovery could even move out. That is the risk we run in microcap, small-cap, and midcap stocks. If money flows out of these stocks, this could significantly impact returns in 2026.
The preparation for a new year must factor in capital flows carefully, weigh valuations cautiously, and assess their prospects objectively. Our assessment should factor in the consequences of flows correctly and nudge us to prepare for a scenario when things get worse. By expecting the worst, we can prepare better for a difficult year when smaller companies will struggle to win back investor confidence and maintain their valuations around the currently elevated levels.