Smallcap stocks have recently taken a hit, prompting many investors to question the reasons behind the dip and whether they should be concerned. In this post, we’ll explore what’s going on with smallcaps, why we chose not to sell during the pullback, and practical steps you can take to navigate the volatility.

The unveiling of Budget 2025 by the Modi Government marks a significant shift in economic direction, signaling a decisive turn towards demand-driven growth while maintaining fiscal discipline. With a pronounced focus on tax relief for the middle class, moderated government capital expenditure, and strategic initiatives in energy and economic reform, this budget sets the stage for a dynamic transformation of the Indian economy.

What’s Happening with Small Caps?

Let’s understand the magnitude of the current correction first. There have been 48 market corrections in 34+ years history of the Nifty and the current correction of ~15% since September 2025 is the 15th biggest correction since 1991.

Small and Mid Caps tend to react more sharply during market corrections but since September they have been moving in tandem with the Large Caps. Only in the last 4-5 days has the smallcap correction escalated to slightly worrying levels.

So what could be the specific factors driving the recent dip:

1. Global Cues: Changes in the U.S. Federal Reserve’s policy stance and rising bond yields typically make investors more cautious, favoring larger, safer stocks.

2. Local Sentiment: Foreign fund flows have shifted away from emerging markets, including smallcaps in India.

3. Valuation Concerns: Smallcap stocks had rallied for months and were trading at higher valuations, making them more vulnerable to sudden corrections.

4. Risk-Off Mindset: Overall market sentiment turned cautious, and smallcaps are often the first to feel the effect of reduced risk appetite.

5. Liquidity Crunch: Due to a number of brokers offering Margin Trading Facility, risk limits being hit can lead to liquidation of whole books, exaggerating the correction.

6. Earnings & GDP Growth Slow Down: Earnings for Indian equities have been disappointing in the last quarter and even in this quarter there are no significant upticks. India’s GDP growth has also slowed down but the estimates have been revised upwards recently by the RBI.

While Direct Equity funds like ours have been affected with the risk rising with concentration, the broader market correction has spared no one, even large Mutual Funds have seen a fall greater than the indices. To put into perspective, imagine a INR 61,000 Cr. fund falling close to 13% in a month.

Fundamentally solid businesses are not immune to short-term panic, which is why even strong companies can see sharp price dips. What we also have to remember is that historically, such drawdowns often set the stage for potential recovery as valuations become attractive.

How did our models react?

Our models have multiple built in layers of risk management - diversification, regime based risk modulation, deallocation to cash and hedging.

We did end up doing all of this in the current correction. Our strategies increased cash allocation to up to 20-25% in the early part of this week (which we have covered up) with Factor strategy also holding 5% Gold. We have been hedged with put options in the Nifty for a couple of weeks, having increased the hedges last week as well. On a notional value our portfolios were hedged 40% with around 20-30% cash allocation ~ so theoretically a protection of almost 60-70%.

But our models were opportunistic as well - holding highly rated, fundamentally strong smallcap stocks, and the meltdown of small caps over the last 4-5 days still pulled down the performance to worrying levels.

Here’s a few things to remember in situations like these:

1. Periodic Corrections: Markets naturally cycle. Short-term pullbacks are both expected and can be beneficial, helping to weed out froth and maintain a healthier market.

2. Calculated Adjustments: We only rebalance based on specific triggers—whether they’re tied to fundamentals or technical indicators. Knee-jerk reactions often hurt long-term returns.

3. Avoid Reactive Exits: Selling at the first sign of trouble can lock in losses and forgo potential gains when the market recovers.

Should You Be Worried About The Market Crash?

Market corrections play a crucial role in preventing overvaluation and unsustainable bubbles. They contribute to healthy market cycles by creating opportunities for more stable, long-term growth. Additionally, risk management strategies, such as maintaining hedges and sufficient cash reserves, help shield portfolios from extreme volatility, ensuring resilience during market fluctuations.

On the macroeconomic front, accelerating government spending and a smaller fiscal consolidation plan for FY26 are expected to support economic stability. Additionally, the Reserve Bank of India (RBI) is actively injecting liquidity and easing regulations to stimulate economic activity.

What Should You Do?

• Avoid Panic Selling: Emotional decisions in volatile markets rarely end well.

• Stick to Fundamentals: Strong, well-run companies usually bounce back when the market stabilizes.

• Selective Buying: Once signs of a market turnaround appear, we plan to deploy our cash systematically to buy undervalued stocks.

How Are We Handling It?

Rather than reacting impulsively to headlines, we are taking the following approach to manage the correction in smallcaps:

1. Maintaining Core Positions: We continue to hold our fundamentally strong stocks, believing their intrinsic value remains intact.

2. Hedging Strategies: We use appropriate hedges to mitigate downside risk, allowing us to stay invested even when markets turn volatile.

3. Proactive Monitoring: Our team reviews market indicators and company fundamentals daily, ready to adjust allocations if we see meaningful shifts.

4. Keeping Cash Reserves: A portion of our portfolio remains in cash, ensuring we can act on opportunities that arise when valuations become attractive.

5. Long-Term Perspective: Rather than trying to time every dip or spike, we focus on compounding returns over market cycles.

Decoding Budget 2025

The Union Budget 2025-26 focuses on a robust economic trajectory driven by inclusive development, private sector participation, and strategic reforms. With the overarching vision of "Viksit Bharat," the government aims to enhance spending power, encourage private investments, and uplift household sentiments to accelerate growth. The government’s commitment to infrastructure spending, MSME support, and private sector participation indicates a continued push for economic expansion. The emphasis on capital expenditure, asset monetization, and policy reforms, such as raising the FDI cap in the insurance sector, should enhance investor sentiment and attract foreign investments. Additionally, the focus on manufacturing and exports, coupled with targeted incentives for sectors like technology, renewable energy, and defense, could create new growth opportunities. However, fiscal discipline remains a key factor, and the projected fiscal deficit trajectory will be closely monitored by the market. If the government manages to strike the right balance between spending and revenue generation, it could lead to a stable and positive market outlook.

Middle-Class Tax Relief: A Response to Perceived Discontent

One of the most striking aspects of Budget 2025 is the sweeping income tax reductions aimed at the middle class. The threshold for the highest tax slab of 30% has been raised from Rs 15 lakh to Rs 25 lakh, providing significant relief to taxpayers. Additionally, individuals earning below Rs 12 lakh are now exempt from income tax after accounting for the standard deduction.

Potential GST Rate Cuts and Interest Rate Reduction

Beyond income tax reforms, speculation is rife about further relief measures through the GST Council. A potential reduction in the top GST slabs of 28% and 18% could provide a further boost to consumption. Additionally, anticipation is building around the Monetary Policy Committee’s meeting on February 7, where an interest rate cut could ease the burden of EMIs and stimulate consumer demand.

Capex-Led Growth Gives Way to Demand-Driven Strategy

Another key takeaway from the budget is the apparent end of the post-Covid phase of government-led capital expenditure growth. While the government has allocated Rs 11.2 lakh crore for capex in FY25-26—marginally up from Rs 11.11 lakh crore in the previous fiscal—the increase is negligible when compared to earlier years. This signals a shift from infrastructure-driven supply-side expansion to a demand-led growth strategy.

The rationale behind this shift is clear. Over the past few years, wage growth has lagged behind profit expansion, and higher interest rates have constrained disposable incomes. By introducing tax concessions, the government is attempting to reinvigorate demand and restore balance to the economy.

Despite this strategic pivot, the stock markets reacted negatively to the budget, with investors adjusting their expectations following the realization that state-driven capital expenditure would no longer be the primary growth driver.

Fiscal Deficit Commitment and Debt Reduction

Even as the government pivots towards demand stimulation, it remains steadfast in its commitment to fiscal prudence. The fiscal deficit target for FY25-26 has been set at 4.4% of GDP, down from 4.8% in FY24-25. Additionally, plans have been outlined to reduce public debt from the current 58% of GDP to 51% by 2030-31.

A major enabler of this deficit reduction has been higher-than-expected dividends from the Reserve Bank of India (RBI), amounting to Rs 2.56 lakh crore for FY25-26 compared to Rs 2.1 lakh crore in FY24-25. These dividends have been bolstered by the RBI’s strategic sale of dollars, highlighting a well-calibrated approach to fiscal consolidation.

Nuclear Energy: A Strategic Expansion

One of the most forward-looking announcements in the budget pertains to nuclear energy expansion. India has set an ambitious target of generating 100 GW (1,00,000 MW) of nuclear power by 2047. To facilitate this, amendments will be made to the Atomic Energy Act and the Civil Liabilities for Nuclear Damage Act, the latter of which has been a longstanding impediment to the India-US Civil Nuclear deal.

The emphasis on nuclear energy recognizes the need for stable baseload power as renewable sources—such as solar and wind—comprise an increasing share of the energy mix. While the 100 GW target is a long-term goal, small modular nuclear reactors are expected to be deployed in the near future. Additionally, the budget reaffirms India’s commitment to energy transition, with continued investments in solar panels, battery technologies, and electric vehicles

Key Features of The Budget 2025

1. Infrastructure and Capital Expenditure

• Asset Monetization Plan (2025-30): A ₹10 lakh crore program to reinvest in new projects.

• Support to States: ₹1.5 lakh crore as 50-year interest-free loans for infrastructure development.

• Maritime Development Fund: ₹25,000 crore corpus for long-term financing.

• Power Sector Reforms: Incentives for distribution reforms and intra-state transmission.

• UDAN Scheme: Expansion to 120 new regional destinations, targeting 4 crore passengers in 10 years.

2. Agriculture and Rural Development

• National Mission on High Yielding Seeds: Focus on resilient crops to boost productivity.

• Prime Minister Dhan-Dhaanya Krishi Yojana: Development of 100 agri-districts to support 1.7 crore farmers.

• Aatmanirbharta in Pulses: A 6-year mission to develop climate-resilient seed varieties.

• Enhanced Credit via KCC: ₹5 lakh loan coverage benefiting 7.7 crore farmers, fishermen, and dairy farmers.

3. Manufacturing & MSME Boost

• Revised MSME Classification: Higher turnover and investment thresholds to promote expansion.

• Credit Cards for Micro Enterprises: ₹5 lakh limit for 10 lakh businesses in the first year.

• First-time Entrepreneur Scheme: Loans up to ₹2 crore for 5 lakh new entrepreneurs over five years.

• Focus on Labour-Intensive Sectors: Footwear, leather, toy manufacturing, and food processing to drive job creation and exports.

4. Digital and Technological Innovation

• AI and Skilling Initiatives: ₹500 crore for AI education; National Centers of Excellence in skilling.

• PM Research Fellowship: 10,000 fellowships in IITs and IISc for technological research.

• BharatTradeNet: A digital public infrastructure for seamless international trade and MSME integration.

• National Geospatial Mission: Infrastructure modernization for urban planning and land record digitization.

5. Financial Sector Reforms

• Increase in FDI Limit for Insurance: Raised from 74% to 100%.

• Partial Credit Enhancement Facility: NaBFID to support infrastructure bond issuance.

• Grameen Credit Score Framework: Tailored for rural entrepreneurs and Self-Help Group members.

• Jan Vishwas Bill 2.0: Decriminalization of over 100 regulatory provisions to boost ease of business.

6. Taxation and Investor-Friendly Policies

• Corporate Tax Stability: Introduction of New Income Tax Bill to rationalize direct taxes.

• Personal Tax Relief: Doubling the senior citizen tax deduction limit to ₹1 lakh.

• GST & Customs Simplification: Rationalization of industrial goods tariffs and promotion of MRO (Maintenance, Repair, and Overhaul) incentives.

• TDS and Compliance Ease: Extended time for updated tax return filings from 2 to 4 years.

Interest Rate Cuts Coming Soon?

The RBI recently injected about ₹1.5 trillion into the banking system, heightening the chance of a repo rate cut at the upcoming MPC meeting. The repo rate has remained at 6.5% since April 2023, following a 250-basis-point hike between May 2022 and February 2023 to tame inflation.

With economic growth slowing to 6.4% in FY25—its lowest in four years—and inflation moderating to 5.2% in December, economists believe a 25-basis-point cut could help support growth. Food and beverages inflation has reached a four-month low, and inflation excluding vegetables has stayed below the RBI’s 4% target for 12 consecutive months. Although edible oil inflation remains high, the broader downtrend in prices may bolster the case for a rate cut.

Overall Outlook For Indian Markets & Economy

• Market-Wide Drawdown: Major fund houses and portfolio managers are all feeling the pressure—this isn’t isolated.

• Broad-Based Correction: It’s not about one sector or strategy; it reflects a temporary risk-off sentiment.

• Long-Term Positivity: These pullbacks can offer long-term investors the chance to accumulate quality assets at more reasonable prices.

Sentiment Indicator Enters Buy Territory

Morgan Stanley’s proprietary sentiment indicator has entered buy territory for the first time since mid-2022. While it could still decline further, as seen in March 2020, the current fundamentals do not justify a major deterioration in stock market sentiment. Government expenditure is accelerating, and fiscal consolidation in FY26 is expected to be significantly smaller than in FY25, reducing economic pressure.

Technical Indicators hint at a pullback

Less than 18% of Nifty 500 stocks are trading above the 200-day moving average (DMA), and only 8% are above the 50 DMA, reflecting widespread market weakness. Additionally, the number of stocks reaching 52-week highs has fallen to just 1, while those hitting 52-week lows have surged to over 75, highlighting bearish sentiment. Foreign Institutional Investor (FII) short positions are nearing extreme levels, which often precede market recoveries. Furthermore, the Nifty Small-Cap index has declined by 20% in the past two months, suggesting oversold conditions. Historically, after such oversold conditions, markets tend to see some reversal in form of a pullback.

Key Takeaways

• Stay Calm & Disciplined: Don’t let volatility derail your investment strategy.

• Leverage Volatility: Corrections often reveal bargain opportunities.

• Open Communication: We’re watching the markets closely and will share updates as the situation evolves.

Smallcap stocks are feeling the brunt of shifting market sentiment, but corrections like this are a normal part of the investment cycle. By focusing on fundamentals, maintaining a level head, and being ready to seize opportunities when the market stabilizes, you’ll be better positioned to weather the volatility.

For investors, financial planning post-budget will require adjustments based on tax changes and new investment avenues. The rationalization of direct taxes, especially for the middle class, along with increased exemptions for savings and investments, offers greater disposable income and encourages long-term wealth creation. The enhanced credit availability for MSMEs and startups, along with incentives for long-term infrastructure investments, could create new opportunities in equity and fixed-income markets. Investors should assess sectoral implications—sectors benefiting from government policies, such as infrastructure, manufacturing, and fintech, may see an uptick in investment flows. Additionally, tax-saving instruments, such as revised deduction limits for senior citizens and rental income, should be factored into portfolio rebalancing. Given the evolving macroeconomic environment, a diversified investment strategy with exposure to equity, fixed income, and alternative assets will be crucial for optimizing returns while mitigating risks.