The Ghost of Christmas Past? Smallcap indices see a shakeout, repeating a trend

If we extrapolate the past trend, a couple of more days of selling in the index is possible as in the past such a selling pause around Christmas holidays.

In an eerie trend, Nifty Smallcap and BSE Smallcap indices see a sharp selling in the week prior to Christmas as if the Ghost of Christmas Past plagues the indices. The trend can be spotted in all years since 2018.

Continuing the trend, the smallcap indices fell as much as 4 percent on December 20. The Nifty Smallcap 100 dropped to 14,400 level after making fresh peaks at 15,000 level. BSE Smallcap dropped below 41,000 level after trading above 42,000 mark.

If we extrapolate the past trend, a couple of more days of selling in the index is possible as in the past such a selling pause around Christmas holidays.

The latest shakeout on December 20 (marked in yellow).

One reason that some technical experts point to is that foreign traders try to exit the risky smallcap stocks ahead of the extended holidays (Christmas and new year) as they fear a drop in stock prices. Foreign investor activity reduces significantly around this time as many employees are on a leave.

Jitendra Chawla, a CFA working for a German investment bank, also alluded to this in a tweet. “Every year without fail, one big shakeout happens around 20-25 Dec. seems some (FIIs) sell before going for holidays!,” he said in a tweet.

FIIs have been net sellers in the last three sessions, after being net buyers in the previous six sessions. They have net sold equities worth Rs 1950 crore during this week. However overall, in December, they have net bought Rs 27,775 crore worth of shares, data available with NSE shows.

The selling last year.

Smallcap indices are one of the best performing indices of the year thanks to heavy buying by retail investors as well as increased foreign interest. Nifty Smallcap is up 48 percent so far this year while BSE Smallcap has jumped 40 percent. Both indices have created fresh highs almost daily in the last couple of months. This, though, has led to some froth in the segment,

Another reason for such selling could be surging valuation of smallcap stocks, point out analysts. On a trailing basis, Nifty 50 is valued at 22 times its earnings, while Nifty Midcap 100 is valued at 25 times, and Nifty Smallcap 100 is around 29 times, the most expensive among all major indices.

The sharp rally has also led to some funds to stop inflows as they are finding it difficult to deploy money. Recently, Aequitus Investments said it has suspended new inflows into its funds as the rally has left little room for the firm to find reasonably valued investments.

"The current frenetic and euphoric rally in the small and midcap index over the last six months has reduced the number of stocks that fit within our valuation framework," Bhaiya.

A similar drop in index level in 2021.

The rally in some stocks also leads the allocation to a single security to exceed the permissible limit. Mutual funds are not allowed to have more than 10 percent allocation to a single security. Many mutual and PMS funds have even lower limits, especially for smallcaps, as per their risk management guidelines.

In case the weight of a single security breaches such limits, fund managers are forced to sell stocks to be compliant.

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