Beginning of a small-cap meltdown? Diffusion indicator shows acute stress

The Diffusion Indicator - which shows the percentage of stocks above 20-day SMA - has hit a 20-month low for the Nifty Small-cap 100

The stress in the small-cap category seems to getting serious, with the fall extending for a third day on March 13. Even the benchmark Nifty 50 was trading lower by over a percent at 12:30 PM, with serious weakness visible in the markets as more than 3,333 shares were in decline versus 422 advances. 869 stocks were locked up in the lower circuit on NSE.

Market participants told Moneycontrol that the weakness was on account of brokers asking clients to unwind positions because of increased risk perception. “Brokers are asking clients to unwind positions. Market-to-market losses are increasing and brokerages were asking investors to cut positions or cough up additional margins,” said Purvesh Shelatkar, head institutional desk, Monarch Capital.

Key Indicator Flashing Red

Technical indicators have also turned predominantly bearish as the selloff seems to gather pace.

The Diffusion Indicator - which shows the percentage of stocks trading above the 20-day SMA (Simple Moving Average) - has hit a 20-month low for the Nifty Small-cap 100 index. Only 4% of stocks in the index were trading above 20-day SMA. This figure was more than 90% at the start of the year, signaling extreme bullishness. This degree of panic was seen last between May and June 2022 where the diffusion indicator showed 1% of Nifty Small-cap 100 stocks traded higher than the 20-Day SMA.

Nifty 500, another broader market index also showed a similar trend with 11% of stocks in the index trading above the 20-Day SMA. During the start of the year, 77% of stocks in the index showed near-term bullishness.

At 12.50 pm, the Nifty Small-cap 100 index traded deep in the red, lower by almost 4%. Over the past week, the index has tanked more than a percent. The Nifty Mid-cap 100 index traded lower by 3.14%, falling 4.6% in a week.

On February 28, an industry body, the Association of Mutual Funds in India (AMFI), asked asset management companies (AMCs) to put in place a policy to protect investors in small-cap and mid-cap segments in light of the froth building up in the broader markets.

AMFI has asked fund houses and managers to take appropriate and proactive measures to protect investors, including but not limited to moderating inflows and portfolio rebalancing, etc.

Small and mid-sized funds have seen high inflows, causing concern among authorities about how they would hold up in the event of a sharp market selloff. The Securities & Exchange Board of India (SEBI) has also been reviewing stress tests conducted by such funds, according to earlier reports.