What are the reasons behind heavy sell of in midcap and small cap stocks ?
What changed overnight in these counters ? What Regulations initiate the sell off exercise ?
Midcap Smallcap Crash Saga is seen in Indian markets since last few sessions. Small and mid-cap stocks have experienced a significant downturn, with declines ranging from 20 to 60 percent over just a few days. The sudden shift in their fortunes can be attributed to changes in the rules governing margin pledges for loans and margin trading. There are some prime reasons behind this Midcap Smallcap Crash
A recent regulatory circular has resulted in 1010 stocks, mainly in the small and mid-cap category, being removed from the list of ‘collaterals’ acceptable for margin pledges. Previously, clearing corporations accepted 1730 stocks for margin pledges, but this number may be reduced to around 700 stocks. Furthermore, banks and non-banking finance companies will no longer accept these stocks for loans or will provide less money against higher pledges.
This change has had a cascading effect, impacting the MTF book of stockbrokers and the stocks pledged as collateral with brokers. High-net-worth individuals and big traders, who often leverage their positions by pledging their holdings, have been particularly affected. The inability to generate leverage due to the lack of acceptance as collateral has led to a significant unwinding of positions in these stocks, causing a widespread sell-off in the small and mid-cap segment.
In addition to these regulatory measures, periodic surveillance measures and circuit filter curbs by exchanges have further contributed to the selling pressure on these stocks. Overall, experts believe that the game of demand and supply in small and mid-cap stocks has been significantly impacted by these regulatory changes.
The exchanges issued a circular in July to reduce the list of collaterals. The impact was not immediate as the margin of hair cut compared to the full amount of collateral deposited was gradually increased. For example, stocks that were previously granted trading limits or loans of 80% and 75% saw their limits reduced to 40% in the following months after the circular. However, in November, the value of loans on several stocks will drop to zero, causing panic. In simple terms, for many stocks worth Rs 100, where the trading margin or loan extended stood at Rs 75 or Rs 80 in July, it decreased to Rs 40 in October and may drop to zero from November. As a result, unwinding positions in nearly 1000 stocks and stocks purchased using the limits based on the 1000 stocks as collateral has created a precarious situation.
The regulatory circular affected stocks such as Tata Investments, HUDCO, Adani Power and others. Stocks like Paytm, Suzlon, YES Bank, Bharat Dynamics, Autumn Investments, Atul Auto, Jyoti CNC Automation, AllCargo, Tejas Networks , NBCC, Inox Wind, Jupiter Wagons, KIOCL, JBM Auto, Hatsun Agro Product,Go Digit and IRB Infrastructure are among those where very little or no leverage will be extended. These stocks, along with many other well-known small and mid-cap companies, have generated high trader interest.
other than this, geopolitical tension and weak to flat Q2 numbers are also the probable reasons behind sell off seen in mid cap and small cap stocks. Amid concerns about escalating tensions between Iran and Israel, mid-cap and small-cap stocks have been underperforming after a correction. Should there be a significant sell-off in the US and global markets, Indian markets could face a correction as well. It’s worth noting that many small-cap and mid-cap stocks are currently trading at high valuations. For instance, the Nifty 500 Index, which encompasses small and mid-caps, had a cross-cycle adjusted price-to-earnings (PE) ratio of 45.5x as of the end of July. This places the index in the 99.5th percentile of its monthly values since 2007, signaling historically high valuations. Despite the stretched valuations in the midcap and smallcap segments, experts see strong growth potential in specific companies within these sectors. Given the mixed signals in the broader market, investors are advised to take a stock-specific approach while carefully weighing the risks and rewards of these high-growth categories. Analysts emphasize the importance of caution as volatility may increase, but they also note that opportunities persist for those with a long-term perspective.