Structural reset
It is in the nature of stock markets to over-react. But when a bull phase ends and a bear phase unfolds, it is usually because corporate or economic fundamentals are being reset in some way. Understanding what is being reset is important to making the right choices when looking to bottom-fish.
Today, three structural changes are underway, which are likely to impact Indian companies. One, even if Trump concludes his Iran misadventure, it appears unlikely that the supply shock to crude oil and its derivatives will recede for several months. As West Asia may remain conflict-ridden, the oil market may continue to factor in a higher geopolitical risk premium than before the war. This will likely elevate input costs for all sectors which are net users of petroleum or its downstream products. This calls for sticking to companies and sectors which have wide margins and pricing power to pass on input cost spikes, while giving a wide berth to companies with thin margins that are at the mercy of buyers.
Two, returning inflation from elevated crude oil and commodity prices will likely force the Monetary Policy Committee (MPC) to switch from rate cuts to rate hikes over the next year. Returning inflation could, in fact, be a global theme which prevents central banks from employing their time-tested tool of cutting rates to prop up asset prices. Higher interest rates make an automatic case for lower equity valuations. In the post-Covid world, Indian investors have gotten quite used to paying pricey multiples for growth stocks. They need to flip this mindset now and look for growth that comes with modest valuation.
Three, while AI-disruption fears have faded into the background after the recent spike in energy costs, AI adoption appears to be here to stay and will likely benefit some sectors while upends others. The identity of the winners and losers remains up in the air. Understand whether a sector or company is a net gainer or loser from AI, before swooping in on it.
Don’t chase small-/micro-caps
When markets bottom out after a sharp fall, small-cap and mid-cap stocks usually suffer more brutal reverses than large-caps. They also slip into a valuation discount to large-caps.
This happens for three reasons. One, when external risks such as raw material price spikes, interest rate hikes or adverse exchange rate moves trigger a downturn, small-sized and mid-tier companies in a sector take a sharper earnings hit than their larger peers. Two, small-cap stocks are owned more by retail investors than by institutions. The former can panic more when corrective phases arrive. Three, in any correction, small-cap stocks fall more than their fundamentals warrant because they bear the brunt of vanishing liquidity on top of uncertain prospects.
This trend is yet to play out in the current market fall. During the Covid crash of February 2020, the Nifty50 fell about 30 per cent in a month’s time, while the Nifty Midcap 150 index plunged 33 per cent and the Nifty Smallcap 250 index crashed about 40 per cent. At the bottom of the 2020 bear market, the Nifty50 and Midcap 150 index traded at a PE of about 18 times. The Nifty Smallcap 250 saw its price-to-book dwindle to just 1 time (its PE was distorted by loss-making companies).
In the ongoing correction from September 2024, the Nifty50 and Nifty Midcap 150 are down about 15 per cent from highs, while the Nifty Smallcap 250 index is down 21 per cent. However, the Nifty50 PE is below 20, while the Midcap 150 index (31 PE) and Smallcap 250 (27 PE and price to book of over 3 times) trade at a stiff premium to the Nifty50.
This suggests that the bottoming out process may not be over yet for these segments of the market. If you’re looking to bottom-fish today, stick to large companies and sector leaders rather than small-caps and also-rans, because there may be more pain in the offing.
Skip what fell the most
When you’re betting on a market rebound, temptation is strong to bet on stocks that (you think) will help you recoup losses in double-quick time. Many investors believe that what fell the most will rise the most. This is a sure way to decimate your wealth.
When markets revive after a structural reset, the leaders of the new bull market are often completely different from those in the previous one. After the 2008 capex bust, infrastructure, real estate and capex stocks were the biggest losers falling 70-80 per cent. They took several years to get back to their original prices, while IT and pharma stocks led the new bull phase. After the Covid crash, pharma and IT stocks sank into oblivion while auto, consumption and hospitality led the rally.
It is quite difficult at this stage to spot the sector leaders of the next bull market. But the post-Covid rally suggests that caution is warranted on discretionary consumption, auto, hospitality and realty, which were big gainers of the ‘unlock’ theme.
Stay clear of sectors or themes that have tanked much more sharply than the indices since September 2024. Bargain-hunt in sectors which have underperformed for the last five years.
Don’t go all in
Given all the above uncertainties, if you’re raising cash to invest in equities, don’t go all in at once.
Usually, new bull markets take shape only after investors swing from optimism to despondency to outright panic. While optimism about the India story has certainly turned to gloom over the past year, a few market indicators are yet to signal a capitulation phase. Valuations of small- and mid-cap stocks remain elevated. India VIX remains at moderate 25 levels, compared to 70-80 during the previous panic phases.
This makes it hard to predict when the corrective phase will end, and the next recovery will take shape. Different sectors are also likely to bottom at different times. Don’t deploy all your cash at once. Hold some dry powder to participate in future falls.
The author is a Contributing Editor
Published on April 4, 2026