Why India's Domestic Small/Mid-Caps are the Safe Harbor Amid Global Storms

The recent Moody’s downgrade of U.S. debt to AA1 has reignited fears of a global liquidity crunch, with spillover effects already rippling through emerging markets. For investors in Indian equities, this presents a critical juncture: pivot toward domestically oriented small/mid-cap firms to hedge against the cyclical overhang plaguing the IT sector. While global macro headwinds loom large, India’s domestic economy—bolstered by resilient Q4 earnings from companies like Divi’s Laboratories and trade deal-driven growth—is proving to be a fortress of stability.

The IT Sector’s Cyclical Overhang: A Minefield of Risks

The Indian IT sector, long the darling of foreign institutional investors, is now a cautionary tale of reliance on U.S. discretionary spending. Q4 FY2025 results revealed stark vulnerabilities:
- Revenue declines: Major players like Infosys (-4.2% QoQ) and Wipro (-1.2% QoQ) saw sequential drops, with full-year growth for the sector hitting a four-year low of 3.78%.
- Margin erosion: Margin contractions at TCS (-0.8% QoQ) and Infosys stemmed from cost pressures and delayed client spending.
- Structural headwinds: U.S. banks and corporates, key clients for IT firms, are now prioritizing cost-cutting over discretionary tech projects amid recession fears.

The data underscores the IT sector’s cyclical exposure. With U.S. Treasury yields hovering near 5%, capital outflows from IT stocks—a traditional "buy on dips" sector—are accelerating. Investors fleeing perceived risk are right to question whether IT’s 10-year valuation averages (now near historic lows) reflect reality or desperation.

Domestic Small/Mid-Caps: Resilience in the Face of Global Uncertainty

While IT falters, domestically oriented small/mid-caps are thriving. Their Q4 FY2025 results highlight a stark contrast:
1. Profit growth outperformance: Mid-cap firms delivered 18% YoY PAT growth, versus IT’s paltry 0.6%.
- Divi’s Laboratories (healthcare): PAT surged 25.6% YoY to ₹667 crore, fueled by its Unit III expansion and CDMO contracts in peptides.
- Persistent Systems (IT mid-cap): Revenue rose 4.3% QoQ, targeting $2 billion FY2026 growth via niche cloud and AI services.
2. Trade deal tailwinds: India’s $250 billion+ trade agreements with the UAE and U.S. are boosting sectors like pharma (Divi’s), engineering (Larsen & Toubro), and auto (Ashok Leyland).
3. Structural growth drivers:
- Make in India: Subsidies and tax incentives are driving manufacturing-led growth, with companies like Kaynes Technology (electronics) leveraging supply chain diversification.
- Healthcare consolidation: Aster DM Healthcare’s merger to create a 10,000-bed hospital chain exemplifies India’s underpenetrated healthcare market.