Small stocks crumble under panic pressure

New Delhi: The stock markets, which were on a relentless upward journey for the last two weeks, were forced to correct as the government and regulatory authorities like SEBI went into an overdrive to investigate the phenomenal rise in small cap stocks. Rumors of income tax raids of stock brokers and intelligence agencies tracking overseas accounts of past scam masters were picked up by the media and created further panic among traders and investors.

The statements by the opposition political parties and the left parties terming the stock market rally as a big scam did not help matters either. Demands for a new investigation into the participatory notes issued by FII's accentuated the fears about a scam in the markets. Participatory notes are contracts issued by FII's to overseas investors who do not want to get themselves registered with SEBI.

P-Notes, as they are popularly called, are a very popular instrument and a significant portion of FII funds are raised in this form. The allegation is that a major part of the money flowing in through P-Notes is in fact black money siphoned out of the country and not genuine foreign investment.

The sharp rise in the indices over the last few months had encouraged many traders to take leveraged positions. Once the markets turned weak, all these traders with leveraged positions rushed to exit their positions. The move by the exchanges to fix a 5-per cent circuit filter for many small stocks earlier this week prevented these traders from exiting their positions as there were no buyers in most of these stocks.

Hence, they were forced to exit their positions in blue chips and better quality small stocks to cover up the losses. This process turned into a vicious circle and the markets saw their biggest decline since the dark Monday crash after the May 2004 elections.

The small cap stocks on the BSE were the most affected as most of them found no buyers. Most of these companies are virtually defunct with no operations or fundamentals to talk about. Manipulators have been on the rampage in these stocks, pushing up stock prices by 10 times and even 50 times over the last one year.

The high flying stocks in the mid-caps and some momentum stocks in the large caps were also affected. Stocks like Reliance Capital, Reliance Energy, VSNL, Indiabulls etc had seen significant appreciation over the last few months on speculative news flows. These stocks lost significant ground as traders had large leveraged positions in them.

Though the markets stabilised to some extent today, the indices are expected to remain volatile next week as well. More news flow is expected on the investigations by SEBI and other agencies.

Global markets are also facing uncertainty. Most analysts are keenly waiting for the derivatives settlement due next Thursday before taking a directional call on the markets.