Rout on in small, mid caps: Experts blame negative news flow, Q3 earnings

Small- and mid-cap stocks are witnessing a carnage due to unwinding of speculative bets amid regulatory curbs.

On Tuesday, the Nifty Smallcap 100 and Nifty Midcap 100 indices extended their sixth day of declines to 8 per cent and 4.5 per cent, respectively. The widely tracked Nifty50 index was down just 1 per cent, hiding the pain the broader market is going through.

In absolute terms, the decline in market cap of small and mid cap stocks, listed on the National Stock Exchange, during this period is Rs 2.88 trillion. 

Market players say the mid-cap selloff has accelerated in the past week on negative news flow around governance and financial impropriety. Also, underwhelming earnings in the March quarter and valuation premiums over large-caps have added to the already weak sentiment.

Many investors had placed leveraged bets on shares of smaller companies. They are being forced to unwind their positions following the recent crash, say brokers.

The Nifty Smallcap index has corrected 24 per cent from the all-time closing high it hit in January, while the Nifty Midcap index is also fast approaching bear territory as it is down 16.3 per cent from its all-time closing high earlier this year. In comparison, the Nifty50 index is down less than 5 per cent from its peak.

The Securities and Exchange Board of India’s new norms on mutual funds categorisation and trading curbs imposed by exchanges have contributed to the selling, say market players. In the last two months, the NSE and BSE have moved more than 100 stocks to the so-called additional surveillance measure (ASM) to curb speculative trading.

Foreign brokerage UBS says the underperformance of small- and mid-caps stocks will continue.

“There is little comfort, valuation wise,” says Gautam Chhaochharia, head of India research, UBS Securities. He adds mutual fund and portfolio management service (PMS) flows, which have driven up stock prices, are moderating.

“We expect the strong local MF flows to fade as demonetisation-led liquidity abates and if interest rates rise,” says Chhaochharia. The small- and mid-cap indices are trading at a 20 per cent premium to large caps. Historically, they have traded at a discount to Nifty in terms of price-to-earnings (P/E) multiples. Analysts see the premium shrinking due to macro headwinds such as the interest rate rise and weak earnings momentum.

Independent analyst SP Tulsian said the re-jig by MFs, along with Sebi’s ASM norms are forcing fund houses and wealthy investors to move from smaller stocks to large caps. Anticipating the crash, fund managers focused on smaller stocks have been raising their cash levels. The top five small-cap funds, which together manage assets worth Rs 300 billion, have increased their cash levels to as much as 13 per cent at the end of March. Industry players say the cash component has only gone up since then.

“We have been discouraging investors from putting in more money in this space. Mid- and small-cap stocks were on a slippery slope as valuations had run far ahead of fundamentals,” says a fund manager managing Rs 72 billion. Among the stocks that have seen the biggest drop in the past six sessions are Manpasand Beverages, CG Power, Bombay Dyeing, PC Jeweller and Dilip Buildcon.

Mid-cap stocks in the pharmaceuticals, state-owned banks, financials and technology sectors have corrected the most in the year to date.

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