Smallcap stocks have recovered sharply amid expectations of earnings growth after bottoming out in Q2, indications of a recovery in the government's capital expenditure cycle in H2, and the BJP's victory in the Maharashtra elections, just as retail investors were growing impatient with veterans' warnings that a bull market correction can throw the baby out with the bath water.
On Wednesday, the BSE Smallcap index, which consists of 945 firms, surged 11% to a new record high of 57,799, since the market began to factor in the BJP's electoral victory on November 22.
During that time, the market capitalization of all smallcap stocks in the index increased by Rs 7,77,491 crore. Ashapura Minechem, 63 Moons, Oriental Rail, Lincoln Pharmaceuticals, Greaves Cotton, EKI Energy, Swan Energy, Nelco, Shivalik Rasayan, and HEG were among the stocks that saw the biggest jumps, ranging from 40 to 86%.
The dramatic rebound in smaller companies indicates that animal spirits are returning to the street, despite the fact that the major indices, the Sensex and Nifty, are 6% below their September-end heights.
"Strong gains in a number of industries, including infrastructure, IT, textiles, and pharmaceuticals, are responsible for the smallcap surge. Compared to largecaps, smallcaps have greater sectoral diversification, which has protected them from some of the volatility brought on by outflows of foreign portfolio investors (FPIs).
Rajesh Sinha, a fundamental analyst at Bonanza Portfolio, told ET Markets that this diversity is essential for maintaining momentum and drawing in local investors.
With a substantially greater number of companies rising than falling, the smallcap segment's advance-decline ratio likewise reflects a favorable investor attitude.
The value of the Nifty Smallcap 100 index has almost doubled since April 2023. In comparison to the previous 13 months, smallcap funds experienced the largest inflows last month, per the most recent data from AMFI. The smallcap sector has had inflows totaling about Rs 30,000 crore so far this year, and the category has expanded by more than 46% overall.
Strong indications of a capital expenditure recovery in 2HFY25 are being seen by market insiders, as numerous projects are currently being bid out and execution is probably going to pick up speed.
"While Railways is, surprisingly, ahead of the full-year run-rate and may not show strong 2H seasonality, Defence, Roadways, and Communication could show a sharp sequential jump. Front-loaded spending in FY24 (52% of targeted capital expenditure in FY24YTD) will make YoY growth for ROY25 appear more remarkable," according to Seshadri Sen of Emkay Global.
Analysts anticipate a growth pickup in H2FY25 compared to H1FY25 in terms of earnings as well, since H1 was impacted by the monsoons and elections because of labor availability, less government spending, etc.
"A 15% drop in central government capital expenditures in 1HFY25, as opposed to a 43% increase in 1HFY24, resulted in muted results for companies that depend on government spending. It is anticipated that this slowdown will only last temporarily, and that normalization will occur in 2HFY25. There are some signs of growth in rural demand, but urban demand is waning." Venkatesh Sanjeevi of Franklin Templeton stated, "We do anticipate a recovery in government capital expenditures in the second half of this fiscal year, which should benefit companies and sectors associated with this theme."
Regarding smallcaps, analysts are cautioning ordinary investors once more not to become overly excited and to base their purchases solely on fundamental analysis.
"Corporate governance issues are widespread in these areas, and limited liquidity can make it difficult for investors to exit specific stocks. While no one has a crystal ball to tell how long the boom in small- and micro-cap companies will endure investors should not underestimate the risks and consider the big picture before making an investment decision," Sharma said.
