Nifty Crosses 20,000, but the Real Bull Market Is in Small- and Micro-caps
An extraordinary bullishness has gripped a segment of the Indian market. On Monday, the benchmark index Nifty 50 crossed 20,000, braving many negatives such as selling by foreign institutional investors, high bond yields in the US and falling global liquidity. However, the real story is the extraordinary rally in smaller companies' stock prices which are shooting up like wild weeds for the sixth month running. From early April, when the current rally started, the Nifty 50 is up only 15.2% while Nifty 500 has rallied 21.26%. Meanwhile, the Nifty Microcap 250 has zoomed 61.3%! More importantly, there is a pattern among the biggest gainers.
These are all directly or indirectly linked to massive government spending that started a few years ago. This includes 1. Railway modernisation, which benefits stocks such as Jupiter Wagons (309%), Texmaco Rail (261%) and Titagarh Rail (207%); 2. Government enterprises such as Mazgaon Dock (233%), Indian Railway Finance Corporation (190%) and Rural Electrification Corporation (134%); 3. Infrastructure companies benefiting from government plans include Patel Engineering (270%), a construction company with a focus on the hydropower sector; Genus Power (227.6%), which specialises in smart meters; and HBL Power (183%), which is focused on batteries, defence and railway signalling. These prices are from last Friday. 
These stocks are running up for a reason—strong and simultaneous government initiatives in multiple directions—something we have never seen before. In the last Union Budget, the government had allocated a stupendous Rs10 lakh crore for infrastructure, of which the railway ministry's allocation was Rs2.40 lakh crore, a 75% leap over that in FY22-23.
The Defence Production and Export Promotion Policy 2020 (DPEPP) has set a revenue target of Rs1.75 lakh crore by FY24-25, implying a 15% CAGR (compounded annual growth rate) between 2019 and 2025. Procurement from domestic industry would double to Rs140,000 crore by FY24-25. The government shipyards (Garden Reach, Cochin and Mazagon) have their order-books full for the next few years and are getting more and more enquiries. 
The allocations made through the Budget are being spent liberally. If pipes and tubes are doing exceptionally well, it is because of the Jal Jeevan Mission and civil construction which is the basis for infrastructure building. Companies doing government work are actually getting paid quickly which is also a major departure from the past. A small listed company, Zen Technologies, which has forecast a sharp rise in its revenues, told analysts that it gets paid within 45 days of invoicing, thanks to the efforts of the defence ministry. These are the reasons why companies from three segments—defence, railways, and urban infrastructure (including road, power, metro rail projects, water and sanitation)—are a mad bull market. 
But what explains the vertical rise in small- and micro-cap companies? 
Some of these companies have never had it so good in the past. Four sectors grew massively in the past two decades due to demographic tailwinds: software, pharmaceuticals, consumer goods and financial services, including banking. They also benefited from the lack of government intervention. But India's smaller private companies have never previously benefited from a well-managed, strong and secular growth due to government schemes and spending. In the past, growth due to policy initiatives was limited to roads, power and mining. In each of these sectors, big shady business houses walked away with large, gold-plated projects with the help of collusive bureaucrats and bankers. But they often failed to deliver due to inefficiency and corruption. 
Today, massive spending on defence, metro rail projects, the tremendous push for renewable energy and production-linked incentives (PLI) to boost manufacturing in 14 sectors has led to more broad-based and significantly larger opportunities for all. Many private companies operating in these areas are small- to mid-cap stocks because they never before had a growth opportunity that is a significant multiple of their current operations. This has led to a sharp upsurge in the stock prices of this group of companies as the market is confidently discounting several years of growth. For the past year or more, we are witnessing a new paradigm of growth, a development model that prime minister (PM) Narendra Modi had talked about but did nothing to unleash in the first six to seven years of his leadership. 
The question in everyone's mind is: Will this be sustainable? The answer is not simple. The current model remains hostage to multiple factors in the absence of any effort to reduce the cost of overheads, logistics and other frictional costs of doing business. 
In order to create a sustained, self-reinforcing growth cycle and for spending to continue, We need: 1. Tax revenues to remain buoyant. Revenue from goods and services tax (GST) is continuing to rise on a year-on-year basis but has plateaued this year. Direct tax revenues are flat for the first four months, even as total government expenditure has jumped 23%, mainly due to a 52% increase in capital expenditure. 
2. The value of the rupee, which indicates the competitive strength of the economy, has remained weak and is getting weaker under the pressure of higher oil prices and a lack of export competitiveness. 
3. Government spending usually lacks oversight and only time will tell what is the net impact of spending on railways and infrastructure. The benefit of defence expenditure is easier to visualise in terms of lower imports, higher exports and expanded domestic manufacturing. 
In effect, while the corporate sector has benefited from massive capital expenditure, leading to skyrocketing stock prices, investors would do well to keep an eye on the macroeconomic picture and government finances, not just corporate profits, for signs of trouble. After all, as smart investors would remind you, 'everything is cyclical'. 
In other words, when the cycle is rising, no one foresees or considers what could turn the cycle down. But it inevitably does, especially one created by the government.
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