Smallcap stocks spring back to life as if nothing happened. Are retail investors right?

Some of the biggest gainers in the small and midcap space were BLS International, ITI, SJVN, and Swan Energy with upsides between 10-20% each. Adani stocks, which were among the worst affected in yesterday's sell-off, also rallied up to 9%.

Small and midcap stocks have been under pressure ever since Sebi started flagging the issue about the possibility of froth building in the broader market amid non-stop buying by retail investors.

"There are pockets of froth in the market. Some people call it a bubble, some may call it froth. It may not be appropriate to allow that froth to keep building," Sebi chairperson Madhabi Puri Buch said while comparing valuations with irrational exuberance.

Sebi and the AMFI (Association of Mutual Funds in India) have directed mutual funds to provide additional disclosures for small- and mid-cap funds from this month.

While only time will tell whether today's buying is the case of a dead cat bounce rally, the price action indicates that investors are finding enough value after the dip.

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Prateek Agarwal of Motilal Oswal Mutual Fund said it is a godsend for people who were hoping for a correction to happen.

"Over the last couple of days, stocks have been knocked down 10% minimum and more, so a lot of that fluff is definitely out. But even before that, our thought was if the earnings delta of small over mid and mid over large sustained deeper into the future, even before correction valuation for a long-term investor, this space would have made more money than the larger cap part of the market as long as the quality of business was good," he said.

In the meantime, Kotak Institutional Equities has warned that most mid and smallcap stocks are still trading at full-to-lofty valuations and well above their fundamental value.

"We are not sure if the correction marks a reversal of the market to fundamentals and numbers from sentiment and narratives. If it is the former, many low-quality stocks may still have a long way to fall, in our view," warned Sanjeev Prasad of Kotak Equities.

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