The crash in mid-caps during February highlighted both the fragility as well as the strength of the Indian stock market. Many highly-fancied midcaps such as Opto Circuits, Core Education, Hind Oil Exploration, Educomp, etc., went into tailspins.
As a result of massive falls in these stocks, leveraged long operators were caught on the wrong foot. This led to margin calls, which couldn't be met, followed by enforced sales that drove prices down further. The vicious cycle may still not have ended since several of these stocks recenly hit 52-week lows in the March settlement.
However, even though investors and traders suffered huge losses, the market for these scrips did not dry up. Liquidity was always available. At every stage of the fall, enforced sales found counter-parties willing to buy in the hopes of a recovery. This depth shows the market still has committed domestic players and that's heartening, given that domestic retail and institutions alike have been net sellers for over a year.
The weakness showed in the rapidity at which these stocks declined. The bull market was just about 2% off its 52-week peak at the time the trouble started. In those circumstances, one doesn't expect highly-visible and institutionally covered midcaps to fall 50% in a couple of sessions. However, most of the large positions were held at leverage since operators lacked the deep pockets required to simply buy and hold.
The midcap segment has fallen more than the big indices as a result of this. The CNX500, which includes the top 500 stocks (and hence, the Nifty and Nifty Junior), is up 24% since January 2012 and down 9% from its 52-week high (4,872) on January 22, 2013. The Nifty is up 24% in the same period and down 6.5% from its 52-week high (6,111) on January 29, 2013. If we eliminate the large-cap performance from the CNX500, it's evident that the midcap segment has underperformed the big stocks by a considerable margin. The long-term Advance-Decline ratio for the midcaps is also quite poor.
This sort of thinning out is often an indication of a long-term market top. In this case however, it's also an indication of how dependent India's last bull-run has been on FII inflows. Big stock have outperformed only because the $26 billion of so that FIIs have pumped into Indian equities have been focussed on big stocks. If it wasn't for the FIIs, there would have been no bull run at all. It will need positive commitments of similar quantities in 2013-14 to simply sustain current price.
Now the indications are that global liquidity could tighten because the US is heading into a phase of Budget cuts. If this happens, there is every chance that FII flows into emerging markets, such as India, will also ease off. That would extend the current phase of bearishness and perhaps, push the market into a long-term bear market.