Brokers ask clients to cut leverage as selloff deepens

BSE Midcap index fell 2% in the five trading sessions, BSE Smallcap index declined nearly 5.9% and the Microcap 250 index dropped 7%. The Sensex was up 0.3%.

Analysts said the capital market regulator's heightened scrutiny of smaller shares amid concerns that they are overheated after the run-up in the past year has been a trigger for the selloff in them.

On smallcap and midcap stocks, Sebi chairperson, Madhabi Puri Buch told reporters on Monday, "Some people call it a bubble, some may call it froth," Buch told reporters in Mumbai. "It may not be appropriate to allow that froth to keep building."

Brokers said the comments have prompted them to ask clients to cut their stock positions built on loans, especially ahead of the financial year end on March 31. Investors too are reshuffling their portfolios as part of adjustments for tax purposes.

"The statement from the regulator of the market cannot be ignored hence putting some selling pressure on small stocks," said Mukesh Kochar, head of wealth, AUM Capital. "Mutual funds have been asked to do stress tests on their small- and mid-cap portfolios and also to restrict fresh investments along with other measures while brokers are asking their clients to lower the leverage positions to clean up the books."

On Tuesday, the mid-cap index fell 1.3%, the small-cap index dropped 2.1% and the microcap 250 index declined 2.6%. Brokers said the clampdown on Tibrewala extended the sell-off in several penny stocks. Out of the 3967 stocks traded on the BSE on Tuesday, 3272 dropped, while 625 gained.

Analysts said smaller shares were vulnerable to a decline on account of rich valuations and the Sebi’s remark was only a trigger.

“We believe that the recent downturn in mid and small-cap stocks can be attributed to profit-taking triggered by stretched valuations and heightened regulatory scrutiny on leveraged positions in the stock market,” said Manish Chowdhury, Head of Research, StoxBox. “This has also been on account of recent negative remarks from Sebi regarding the excess speculation in the mid and small-cap segment.”

BSE Midcap index surged 61% in the last year till February 19 while BSE Smallcap index rose 63% during this period. Sensex gained 22% during this year. Many small-cap and micro-cap stocks gained between 100% and 300%.

Analysts are advising caution in this space at this juncture.

“Given the historical volatility of small and midcap stocks, it's crucial for investors to exercise caution in allocating funds, whether directly in stocks or through mutual fund SIPs,” said Gaurang Shah, senior VP, Geojit Financial Services. “Investors should be prepared for the inherent volatility in small, mid, and microcap stocks, as corrective phases have occurred before.”

Investors must not rush to deploy money into small-cap and mid-cap shares despite the recent declines.

“We advise investors to stay on the sidelines until the dust settles and use the dry powder to buy quality mid- and small-cap companies in a staggered manner that have a proven track record of timely execution, a strong management team, and manageable leverage,” said Chowdhury.