You do not have to be too perceptive to fathom that the mid caps and the small caps are in serious trouble. One only needs to look at the three indices in the last 7 months and it is clear that it is the small and mid caps that have clearly underperformed the markets. While the mid cap index may have lost just about 16% since January, the individual damage is to the tune of 40-70% in case of most stocks. In fact, just look at the number of stocks touching 52-week lows each day and the answer is there.
Yes, it is about valuations…
The mid cap and the small cap index were quoting at a serious premium to the large cap Nifty for over 2 years now. If anything, the premium that mid caps enjoyed had only widened. Most mid caps and small caps are either focused product businesses or run on the strength of a handful of clients. This risk was not getting reflected in valuations.
Oil prices played a role
You actually need to look at it in a slightly larger perspective. When oil prices were crashing, it was the mid caps that really benefited. Large caps in India are still commodity driven, mid caps are not. When the cheap oil dividends started to gradually vanish with oil getting back to $80/bbl, it was mid and small caps that were the worst hit. A lot of the cost advantages for the mid caps appear to have gone!
The ASM played a role…
Most traders are already blaming the exchanges and the regulator for throwing the baby with the bathwater. When additional surveillance measure (ASM) margins were imposed, the intent was to curb speculation in smaller stocks. But it ended up forcing down-sizing of leveraged positions in mid caps. It also led to lack of trading interest in these mid cap and small cap stocks. The margins were just too steep to entice traders to come and trade the stock aggressively. Ironically, the ASM may not have curbed speculation but it ended up constraining liquidity in these mid cap counters. This mid cap crash has been largely attributed to it.
LTCG and MF reclassification…
Apart from oil, valuations and ASM, two more factors caused the mid-cap crash. The LTCG tax at 10% resulted in a sharp sell-off in mid caps ahead of the March 31st deadline to get the benefits of zero LTCG tax. Secondly, the new SEBI norms on classification of mutual fund schemes into credible buckets, also forced the funds to sell out on many of their mid cap holdings. The moral of the story is that the correction may be real but it may not exactly be structural. The idea is to focus on the mid caps that have quality earnings growth and credible managements. That is where growth comes from and that is what mid caps and small caps are all about!