In a dramatic turnaround, the smallcap market has staged an impressive recovery, adding Rs 4 lakh crore in the past four days. The BSE Smallcap index soared 6.6%, igniting hopes of a sustained comeback. However, market experts caution that bear markets are unpredictable, often witnessing sharp rebounds followed by fresh sell-offs.

With nearly half of all smallcap stocks still down by at least 40% from their peaks and the index 21% below its December high, the question remains—Is this a genuine recovery, or just a temporary bounce in a volatile market?

Rally driven by select stocks:

The recent surge has been fueled by stocks like Bharat Wire Ropes, which jumped 34%, along with Triveni Turbine, Jyoti CNC Automation, and Ramco Systems, each gaining over 20%. Over the last four trading sessions, the BSE Smallcap index added Rs 4.16 lakh crore to the market capitalisation of its 938 constituent stocks, significantly outperforming the benchmark Sensex, according to ACE Equity data.

However, the broader market still reflects lingering weakness. More than 600 stocks have lost over a third of their value, signaling that the scars of the recent correction have yet to heal.

Experts caution: Valuations still stretched

Despite the recent uptick, experts warn that smallcap valuations remain elevated. According to brokerage firm Motilal Oswal, while the Nifty50 index trades 9% below its long-term average, mid- and small-cap indices are still 22% and 25% above their respective historical averages.

Krishna Appala of Capitalmind highlights that the median smallcap price-to-earnings (P/E) ratio remains at 33x, significantly above its historical average of 20x. He notes that only 10% of Nifty 500 stocks are trading above their 200-day moving average (200DMA), indicating weak market breadth.

"Sustaining this rally will depend on earnings growth and broader market sentiment. Strong inflows into smallcaps have inflated valuations, making them susceptible to corrections if earnings fail to catch up," he added.

Technical indicators signal upside, but risks persist:

From a technical standpoint, analysts suggest the smallcap rally may have more momentum left. Rupak De, Senior Technical Analyst at LKP Securities, expects the BSE Smallcap index to reach 47,500–48,000 in the near term. Rajesh Palviya of Axis Securities concurs but advises caution, stating, "A further recovery is possible in the midcap and smallcap segments, but investors should remain cautious until Nifty sustains above 22,400."

Largecaps offer stability, recovery to unfold in phases:

Market experts believe largecaps are currently a safer bet. Independent market analyst Sandip Sabharwal anticipates a phased recovery. "The sharp sell-off in recent months has pushed the market below fair value. While some small and midcap stocks still appear overvalued, others have entered a reasonable value zone. Largecaps are likely to lead the initial recovery, followed by mid and smallcaps once stability sets in," he said.

Jimeet Modi of Samco cautions investors against indiscriminately chasing smallcap stocks. "Not all beaten-down stocks offer value. Many smallcap companies with weak financials and poor management may continue to struggle even during a market rebound. Investors should prioritize fundamentally strong largecaps for better risk-adjusted returns," he advised. For those hesitant to take direct equity exposure, largecap-oriented mutual funds provide a safer, diversified investment route.