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NEW DELHI: Smallcaps are officially in the bear market now. And retail investors are struggling to understand what is wrong with them and whether they should hold on or book losses.

Fundamental and technical analysts ETMarkets.com spoke to say not one but multiple factors are weighing on the smallcap stocks. They do not see respite anytime soon.

While the re-alignment of mutual fund schemes following Sebis reclassification has had a bearing, forth in valuations amid earnings disappointment has also hurt prospects of this basket of stocks after a secular run spanning several months.

On the technical charts, the bullish years-long trend in the BSE Smallcap index seems to have reversed, and it looks like there is more pain in store. What should investors do?

Fundamental or technical selloff?
In a bull market, it takes no time for smallcaps to first catch up with largecaps, and then rally fast to lofty valuations. Since businesses of smallcap firms are more vulnerable than their largecap counterparts when economys outlook starts deteriorating, smart investors take no time to move out, leaving small investors trapped.

This time is no different, say analysts. The only problem is, the portfolio realignment by mutual funds happened simultaneously, intensifying the pain.

Portfolio re-alignment by mutual funds is indeed one reason, but valuations for many of the midcap and smallcap stocks were running ahead of time for last few quarters, said Sachin Shah, Fund Manager & Head – PMS, Emkay Global Financial Services.

At Tuesdays low of 16,186, the BSE Smallcap index was down 19.80 per cent from its 52-week high of 20183.45 hit on January 15, suggesting that the index was just 20 basis points way from fulfilling the bear market criterion.

G Chokkalingam, founder and Managing Director, Equinomics Research & Advisory, said investors who are smart and nimble have already moved out of smallcaps.

From the 860-odd BSE Smallcap index pack, the median decline from their 52-week highs has been 34 per cent. About 80 per cent of the constituents have fallen more than the index from their respective 52-week highs, said Nitasha Shankar, Senior Vice-President and Head of Research at YES Securities.

“Smallcaps are considered risky due to volatile price movements. As such, it becomes important for one to have the stomach to invest in the same as sharp price movements are part and parcel of investing in such companies. All the more so, in times like these when market sentiment is not at their best,” she said.

BSEs total market capitalisation is down from Rs 157 lakh crore earlier this year to Rs 144 lakh crore as of Tuesdays close. Leave out the Rs 1 lakh crore worth of IPOs, the erosion in market valuation so far this year would be nearly Rs 14 lakh crore, or 15 per cent. But the BSE Sensex is down just 4 per cent, suggesting that the pressure has been mainly on the second-rung stocks.

Technical picture bleak

The daily chart of Nifty Smallcap index has breached its major Double Bottom support just below the 7,500 mark. Though the index remains in the oversold territory and some technical pullback can be expected, it remains in a secular downtrend since the beginning of 2018, said Milan Vaishnav, Consultant Technical Analyst at Gemstone Equity Research & Advisory Services.

SMLCAP-WEEKLY

On the weekly chart, the smallcap index tested its high near the 9,500 mark. At that point, the index remained in a two-year-long primary uptrend. The first quarter of 2018 saw a corrective retracement. The index slipped below the 8,000 mark, but pulled back again. This pullback saw the formation of a Lower Top in the 8,400-8,420 zone, which signalled a potential reversal of the two-year-long primary uptrend, Vaishnav said.

He feels that the trend has reversed as of now, and no significant upmove is likely unless the index moves past the 8,500 mark once again. Until that happens, all pullbacks will remain susceptible to selling pressure at higher levels.

What should investors do
Shankar says it becomes imperative for investors in times like this to relook at the stocks they hold.

For companies that they have invested in from a long-term perspective, it would make sense to go back and see whether their original thesis still stands. If so, making the most of the decline in stock would make sense. But if the investment was speculative in nature and was done based more for speculative purpose, one should simply move out of the stock, she said.

G Chokkalingam divided smallcaps into three categories: one where valuations are too high and companies have failed to live up to the mark in terms of earnings; second, where there are concerns over transparency in management decisions and where fundamentals are faltering and the third, where there are no such issues, but stocks have still fallen because of the broader selloff.

“Investors can exit in the first two cases,” he said. “If one has the conviction that his/her stock lies in the third category, then s/he can do averaging to lower cost of acquisition of such shares,” he said.

Investing in midcap and smallcap stocks has mainly been a bottoms-up approach, particularly in the Indian context. From that perspective, the recent selloff can actually give decent opportunities for long-term investors. Albeit, one needs to be very selective and do thorough homework on the business outlook, management quality (integrity and capability), inherent profitability (cash flow and ROCE-ROE) and be sure that valuations are reasonable even after the recent price corrections, said Shah of Emkay Global.

Chokkalingam added that there could be stocks that have seen a 30 per cent drop because their consolidated debt is too huge to sustain, and there would be others which may have fallen even when a company's cash-to-mcap ratio remains quite high. A re-think on every portfolio is a must at this point, he advised.

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