A $775 Billion India Stock Rally Faces Risk As Small Caps Overheat

A significant shift in investor preference toward smaller stocks has occurred in conjunction with the rally in Indian equities, which has increased the market’s total valuation by $775 billion in a little more than five months.

As the domestic economic outlook becomes more clouded ahead of the national elections next year and gauges of small and mid-cap shares show signs of overheating, this poses risks.

India’s ongoing recovery in capital expenditure is likely to benefit smaller businesses more. In contrast, concerns about the impact of a possible global recession on the nation’s major IT firms and the results of a short-seller campaign against the vast organization controlled by billionaire Gautam Adani have held back larger stocks somewhat.

The US stock market, on the other hand, has been dominated by a small number of technology mega caps capitalizing on the boom in artificial intelligence to the exclusion of smaller companies.

From its low in March, the Nifty Midcap 100 Index has gained 37%, while the blue-chip NSE Nifty 50 Index has gained 16%, bringing the ratio of the two to an all-time high. According to data compiled by Bloomberg, the midcap gauge experienced a drop of approximately 25% over the following nine months after the previous such peak, which occurred at the beginning of 2018.

However, the recent uptrend in Indian stocks’ near-term prospects have been tempered by the sluggish pace of gains in smaller stocks in comparison to large caps.

India strategist at JPMorgan Chase & Co. Sanjay Mookim said, “The outperformance is definitely getting into an extreme territory.” Mookim also said, “there is a natural limit” to how much higher midcaps can go. He projects that the Nifty 50 will be down 5% by 2023.

The rally is also poised for some consolidation, according to technical indicators. The Nifty Smallcap 100 Index’s momentum has surged to its highest level in nine years, rising 46% from its March trough. The 14-week relative strength index of the gauge is now around 86, which is higher than the 70 level that is typically thought to indicate overbought levels.