Mid, smallcap indices drop most in 9 months; Nifty50 off new high

Concerns about irrational exuberance driving the broader stock rally caught up with the mid and smallcap universe on Tuesday, triggering their worst single-day rout in 2023. The benchmark Nifty50 index, on the other hand, made a fresh lifetime high of 20,110 on an intraday basis before ending in the red for the first time in eight sessions.

The Nifty Smallcap 100 index plunged 532 points, or 4.1 per cent, to close at 12,450, while the Nifty Midcap 100 index dropped 1,274 points, or 3.1 per cent, to settle at 40,170, logging their worst day since December 23. On Monday, the two indices had hit new highs, having rebounded over 40 per cent each from this year’s lows.

The sharp selloff shaved off Rs 5 trillion in market value of the beyond -top 50 companies, which account for less than half of the total market capitalisation. The top 50 stocks lost only Rs 60,000 crore in market value in Tuesday’s trade. This highlights the risk of investing in smaller companies, where the rise can be meteoric but the fall, too, can be steep.

Shares of public sector undertakings (PSUs), which have been on a tear lately, were among the top losers. Market players said the fall was on the back of profit-taking after a sharp up-move this year. Rumours that a top foreign fund liquidated large positions also weighed on sentiment.

“We do not see many fundamental reasons for the meteoric rise in the stock prices of many midcap and smallcap stocks in the past few months. The fundamentals of most sectors have not changed much. However, market sentiment is quite exuberant,” a note by Kotak Institutional Equities said on Monday. “We see risks of lower profitability and lower valuation multiples due to weakening business models,” it added.

Meanwhile, the Sensex and the Nifty50 largely traded flat on Tuesday. While the Nifty50 index closed at 19,993.2, down 3.15 points, or 0.02 per cent, the Sensex ended 94 points, or 0.14 per cent, higher at 67,221. In the past eight sessions, the Sensex has risen 2,390 points, or 3.7 per cent. From this year’s low, the index is up nearly 17 per cent. However, the Sensex is yet to topple its lifetime high of 67,619, logged on July 20.

Following a rout in the broader markets, the market cap of the BSE-listed companies fell by Rs 5.6 trillion to Rs 318.7 trillion ($3.84 trillion).

The sharp rally in mid and smallcap stocks this year has lured many new and existing retail investors into investing in these companies. In August, 3.1 million new demat accounts were opened— the most since January 2022.

“In the last 12 months, 28 million new investors have come to the market. Many are unaware of the nuances. The meltdown is likely to continue because there is no liquidity. Even if the overall market capitalisation declines by 1 per cent, smallcaps are going to suffer badly. Immediate buying support will come only for the index and large-cap stocks from institutional investors,” said Chokkalingam G, founder of Equinomics.

Many new smallcap favourites of institutional and retail investors have risen in the last three to six months, with the expectation of a decent investment cycle. However, analysts expressed concerns about the quality of many of these stocks, given their weak execution and governance track records.

“In addition, many of these sectors fall in the B2G (business-to-government) or B2B categories, which raises issues around execution and profitability. We believe that market expectations for both revenues and profitability may be too optimistic across these sectors,” said the note by Kotak Institutional Equities.

“It’s a recurring trend. Whenever smallcaps do well, the expectations become too optimistic. And one has serious doubts about whether some will turn around because of their huge debts,” said Chokkalingam.

Going forward, analysts said, a certain amount of correction is due as smallcaps have seen a one-sided rally since March this year.

“A correction was due and is likely to be broad-based, swift, and healthy. This year is likely to be a good year. We might see a 10-12 per cent correction, and once the excess froth is absorbed, then we will resume our upward journey,” said Jimeet Modi, CEO of Samco Securities.