India’s smallest listed companies are outperforming the large ones for a second straight day. That reverses October’s pattern, when small stocks lagged badly.
India’s smallest listed companies are leading the market rally. On Thursday, the Nifty Microcap 250 index rose about 2.02% by midday, ahead of the Nifty 50’s 1.8%. The Nifty Smallcap 250 rose about 1.44%, the Nifty Midcap 100 1.24% and the Smallcap 100 1.26%.
On Wednesday, the Nifty Smallcap 100 rose 2.00% and the Midcap 100 1.55%, while the Nifty gained only 0.63%.
That is a clear change from earlier in the rally. On Tuesday, foreign investors bought heavily and the Nifty rose 1.58%, but the Smallcap 100 gained only 0.3%. The early gains were driven by large companies.
From laggards to leaders
The change is significant because small stocks had a very weak October. The Nifty Smallcap 250 fell about 5% during the month, while the Nifty 50 rose about 2%, according to market data. Investors had moved money into large, liquid companies during the uncertainty of the Gulf crisis.
Smaller companies are usually more sensitive to three factors, all of which have improved sharply this week.
Interest rates. Small companies tend to borrow more relative to their size and have less access to cheap funding. When rates rise, their costs increase more. Falling oil has reduced the chance of another RBI rate increase in December, which helps them more than large companies.
Raw material costs. Many small manufacturers have limited pricing power. When raw material costs rise, they often cannot pass them on, and their margins suffer. Cheaper oil eases that pressure.
Market mood. Small stocks typically rise more than large ones when investor confidence improves, and fall more when it weakens. After six days of gains, confidence has recovered strongly.
Who is buying
The buying pattern also points to the change. Foreign investors, who have driven much of the rally, mainly buy large companies. The broadening suggests domestic investors, including retail investors and smaller funds, are now joining in.
That fits the pattern over the past two days: domestic institutions sold large companies on Tuesday and Wednesday, while smaller stocks rose. Some domestic money may be moving from large stocks that have rallied into smaller stocks that lagged.
The caution
Small stocks carry more risk. They are less liquid, so prices can move sharply in both directions. They are more exposed to individual company problems. And their valuations, which reset during the October decline, can quickly become stretched again in a strong rally.
History also suggests caution. Over the long term, data on Indian indices show the Nifty Midcap 150 has outperformed the Nifty Smallcap 250 over most five-year periods, even though small stocks are riskier. Large rallies in small stocks are often followed by sharp corrections.
For investors, the current rally in small stocks is a sign that confidence is spreading across the market, which is generally healthy. But after a fast move, the risk of a sharp pullback is high. The rally in small stocks will last only if the conditions behind it hold: low oil, stable interest rates and continued foreign buying in the large companies that set the market’s direction.
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