BSE Midcap, Smallcap indices surge up to 10% this month, outshining Nifty 50, Sensex; is a stock market bubble brewing?

The Indian stock market looks set to extend its winning streak to the third consecutive session in May, helped by easing tariff worries, improving macroeconomic conditions, largely stable Q4 results, and foreign capital inflow.

While the market is witnessing buying across segments, barring intermittent profit booking, a notable fact is the significant outperformance of broader markets.

In May till the 28th, the benchmark Sensex has gained over 1 per cent and the Nifty 50 has climbed almost 2 per cent. However, the broader markets have outperformed significantly, with an over 5 per cent gain in the BSE Midcap index and a 10 per cent gain in the BSE Smallcap index.

Some small-cap stocks such as Suven Life Sciences and Cosmo First have surged more than 80 per cent in the last one month.

Is a stock market bubble brewing?

The sharp gains in the mid- and small-cap segments this month could be attributed to better-than-estimated Q4 earnings and moderation in premium valuation. Easing global risks, the prospects of healthy economic growth, an above-normal monsoon, and the RBI's rate cuts are also among key factors that seem to have boosted the broader market sentiment.

Moreover, experts suggest that retail investors, in the pursuit of quick gains, could be chasing mid and small-caps after their underperformance over the last few months.

Year-to-date, the Sensex and the Nifty 50 have gained 4 per cent and 5 per cent, respectively, while the BSE Midcap index has declined 3 per cent and the BSE Smallcap index has suffered a loss of 5.5 per cent.

"The outperformance in mid- and small-caps this May is a mix of factors, including geopolitical tensions like the India-Pak war scare that have eased, US tariff rhetoric that has softened, the monsoon forecast and the above-expectations Q4 earnings. All of this has improved sentiment toward India’s domestic story," Trivesh, COO, Tradejini, observed.

Trivesh underscored that the pharma and FMCG have seen renewed interest due to rising income levels and steady rural demand, while niche mid-cap names in capital goods, chemicals, and auto ancillaries continue to offer structural opportunities.

Shrikant Chouhan, the head of equity research at Kotak Securities, underscored that the Nifty 50 is trading at 19 times the one-year forward earnings for FY27, which is expensive. However, the market appears to be relatively relaxed despite uncertainties in global macroeconomic conditions.

"In such situations, it is common for activity to shift toward mid and small-cap stocks. Our strategy should focus on a bottom-up approach," said Chouhan.

According to Pawan Bharaddia, the co-founder of Equitree Capital, the crux of this rebound in small and mid-caps has been on two counts primarily – stabilisation of geopolitical issues including India-Pakistan, Tariffs uncertainty being postponed and earnings growth coming about in small and mid-caps.

"Basis Q4 announced till date, large caps have reported about 9 per cent year-on-year (YoY) growth, whereas mid-caps have delivered about 12 per cent growth. Small caps have had a mixed bag. However, that remains always a ground-up investment genre, and if we reflect on our own portfolio companies, we have seen around 18 per cent YoY growth for the quarter. This growth is leading the outperformance," said Bharaddia.

What should investors do?

Experts point out the valuation and suggest maintaining caution in the mid and small-cap segments.

"Investors need to be cautious, valuations are not cheap. Instead of chasing rallies, it's smarter to use corrections to build positions selectively. In this space, patience and quality matter more than timing," said Trivesh.

According to Bharaddia, investors should approach small-caps in a stock-specific manner.

He believes generalising the segment based on headline valuations or growth often leads to distorted reference points and distracts from growing companies.

Another aspect that Bharaddia highlighted is that one should always remember to stagger investments rather than invest the entire funds in one go while investing in small caps.

"Inherently, this genre is volatile, and one would be better off to leverage this volatility by staggered investing rather than getting played out by it," said Bharaddia.

Bharaddia sees a lot of opportunities across engineering, manufacturing, infrastructure, ancillaries and select consumer plays.

"We are largely playing out four multi-year structural themes – increasing export opportunities for Indian manufacturing, import substitution, continuous infra spend and the larger Indian consumption story. We believe these are decadal themes and one needs to just remain invested and allow the power of compounding to play out for wealth creation in these opportunities," said Bharaddia.

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Disclaimer: This story is for educational purposes only. The views and recommendations above are those of individual analysts or broking companies, not Mint. We advise investors to check with certified experts before making any investment decisions, as market conditions can change rapidly, and circumstances may vary.