2 days ago
Defence, railway stocks rally may not be sustainable, warns Ankit Mandholia of Motilal Oswal. Here's why
Expert View: As the Indian stock market witnessed a fresh leg-up from the RBI's policy booster, Ankit Mandholia, Head Equity and Derivatives and Wealth Management, Motilal Oswal Financial Services, decodes the broader impact of the central bank's action on the economy and markets. He also warns of remaining cautious and selective following a sharp rally in defence and railway stocks. Here are edited excerpts from his interaction with Mint.
The RBI surprised markets with an aggressive monetary policy move. They slashed the repo rate by 50 basis points, bringing it down to 5.50%. They also announced a staggered 100 basis points reduction in Cash Reserve Ratio (CRR) to 3%, which will inject about ₹ 2.5 lakh crore into the banking system.
These moves will be beneficial for rate-sensitive sectors like Banks and NBFCs by lowering their cost of funds, and reduced financing cost would boost demand for Housing and Automotive sectors. Lower interest rates and easing liquidity conditions will spur infrastructure activity and revive consumer durable demand as well. Businesses requiring working capital or expansion funding will find borrowing more attractive. This could translate into increased investment, capacity expansion, and potentially higher employment generation.
The RBI maintained its real GDP projection of 6.5% for FY26, while reducing its inflation projections to 3.7% from 4.0% earlier. This reflects RBI's confidence in India's macro trajectory, and this could drive the broader risk-on sentiment.
Front-loading of rate cuts by the RBI addresses the need to spur growth and also shows the RBI's commitment to maintaining price stability while supporting growth.
The Defence and Railway sectors saw significant gains over the past two months, following a dip in March 2025. The Defence sector's market cap hit an all-time high in May'25, recording a CAGR of 55% between FY19 and May'25. The Railway sector's market capitalisation rebounded from its lows, recording a CAGR of 46% over the same period.
The India-Pak tensions (Operation Sindoor), along with strong order book growth and a recovery in broader market sentiments, have fuelled the rerating trends in these sectors. Further, the central government has front-loaded capex in the current financial year (FY26), spending ₹ 1.6t in Apr'25, up 61% from ₹ 992b in Apr'24. In FY26, the government is targeting capex of INR11.2t, a 6.5% YoY growth.
If the positive trend in capex continues in the coming months, it will be positive for the sector, particularly from the railways and defence sides. Moreover, defence companies are eyeing large opportunities from exports of platforms such as Akash missile, MRSAM and defence control systems, where they have already established their product quality in the domestic markets.
While these sectors have long-term structural tailwinds — capex visibility, policy push, and national security focus — the sharp P/E expansion raises a flag. A part of the move is sentiment-led and may not be sustainable.
We suggest a selective approach, preferring companies with a well-balanced revenue mix, control over margins, and the ability to maintain or improve growth profile going forward.
The overall earnings for small-cap stocks declined by 16% YOY in 4QFY25, falling short of the already muted expectations. Despite this, the Nifty Smallcap100 index has surged over 17% in FY26 — raising concerns that the current rally may be resting on fragile fundamentals. This sharp run-up has deprived investors of valuation comfort, with the one-year forward P/E for Nifty Smallcap100 at 25.8x (as on May 2025), representing a premium of 60% to its 10-year average of 16.1x.
The disconnect between price and profits is unlikely to be sustained indefinitely. A broader economic slowdown or further earnings disappointment in small-caps could trigger a quick reversal, especially with retail money driving these names.
We suggest adopting a selective approach, focused toward fundamentally strong small-caps and possibly increasing allocation to mid/large-caps, which have better earnings visibility.
Indian stock markets are facing overhang from global headwinds, including unexpected shifts in US tariff policies (including the recent doubling of the tariff on Steel and aluminium imports from 25% to 50%) and the ongoing geopolitical tensions between Russia and Ukraine and the Middle East countries.
A strong U.S. dollar, high U.S. bond yields and a hawkish U.S. Federal Reserve policy could make emerging markets like India less attractive for foreign investors.
On the domestic front, corporate earnings growth remains a concern. Nifty50 delivered a 3% YoY PAT, reporting a single-digit profit growth for the fourth successive quarter since the pandemic (Jun'20). Consequently, there has been a cut in the Nifty EPS estimate for FY26. Nifty Midcap-100 and Nifty Smallcap-100 indices are trading at 29.3x and 25.8x (as on May'25), representing premiums of ~30% and ~60% to their respective 10-year average, raising concerns about overvaluation amidst muted earnings growth visibility. Additionally, instability in macroeconomic data, both on the global and domestic front could pose volatility risks for the Indian markets.
Therefore, Indian equities are subject to challenges from global headwinds and modest earnings growth, with stretched valuations in multiple market pockets. However, stable domestic macros and improved corporate performance would support long-term growth prospects.
FII flows remained positive for the third consecutive month, at USD 1.7b in May'25, while DIIs invested USD7.9b— their 22nd consecutive month of inflows and the third-highest monthly tally ever. This led to a record 14-month high institutional flow. The AMFI data for May'25 indicated that Mutual Fund SIP inflows remained strong at Rs26,688cr — the highest ever monthly SIP contribution on record. The two-engine flow dynamic — steady DII inflows supported by retail SIPs, and returning FII interest, provides stability to the market. The FII index futures positions remain well below peak, implying that FIIs still have room to scale up exposure, and DIIs appear well-cushioned to support any corrections.
Disclaimer: This story is for educational purposes only. The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.
