Advance-decline ratio hits 17-month low

Indicates that number of declining stocks far exceeds those advancing, and may be a bearish signal

Indicates the number of declining stocks far exceeds those advancing; may be a bearish signal. SUNDAR SETHURAMAN writes

The advance-decline ratio (or ADR) has hit a 17-month low in August, ostensibly on account of profit-taking in midand small-cap stocks.

According to the data from the bourses, the ratio so far this month stands at 0.74 — the lowest since March 2020 (0.56).

The markets had corrected steeply in March last year as the pandemic forced the government to declare a nationwide lockdown.

Interestingly, this time, the decline in the ratio comes during a month when both the leading indices, the Sensex and Nifty, have hit new highs.

The ratio is a popular market breadth indicator. It compares the number of stocks that ended higher against those that ended lower over their previous day’s close (the chart reflects the daily average for the respective month).

The data shows the number of declining stocks far exceeded the number of advancing ones in August. In fact, in absolute terms, at 1,902 for August, the number of declining stocks is the highest in at least 20 months.

While some experts say the decline in the ratio in August may be signalling a short-term corrective trend in the ongoing market rally, a few experts, however, sound cautious.

They say one reason the ratio declined is due to consistent profit-taking in small- and midcap stocks. On a month-to-date (MTD) basis, the BSE Midcap index fell 1.8 per cent and the Smallcap index declined 3.8 per cent, while the Sensex rose 5.2 per cent. Both the indices hit a new high on August 4, 2021, while the Sensex hit an all-time high on August 18. From the March 2020 lows to all-time highs this month, the Midcap index had gained 142 per cent, while the Smallcap index had galloped 208 per cent.

“This is a function of valuation expansion in these stocks, which needs to be corrected at some point,” said Deepak Jasani, head of retail research, HDFC Securities.

Siddhartha Khemka, head of research (retail), Motilal Oswal Financial Services, said investors in a bull market preferred midand small-caps. They don’t have many options in large-cap stocks, which could rally sharply. But once investors are in risk-off mode, they start selling.

“When there is some amount of selling pressure in mid-caps, investors seek refuge in largecaps. Large-caps might offer you lower growth, but the valuations are not that stretched. And the chances of seeing a sharp correction in large-caps is rare unless the circumstances are exceptional. Valuations in the mid- and smallcap segments are steep at the moment. Some profit-booking and risk aversion are emerging after a rally in broader markets,” said Khemka.

But there may be a need to tread with caution.

Ambareesh Baliga, an independent market analyst, said the more astute investors were exiting the mid- and small-cap space. And sentiment is good only because of the gains in the headline indices.

“Some stocks have seen a steep decline, which shows that they were distributed to retail investors at higher levels, and these retail investors are sitting on losses. Many new investors have never seen a crash. There is a difference between reading about a crash and experiencing it. And they are panicking,” said Baliga.

Baliga added large-caps had mainly been insulated from this fall. The correction is more in select mid- and small-caps that have become multi-baggers or have weak fundamentals.

“The stocks that are witnessing a steep correction did not have any fundamentals to support their rally, and people were only looking at momentum. When people buy stocks purely based on market sentiment, it’s not just selling that leads to a correction; a correction can also be due to a lack of buying. When institutional investors and HNIS start panicking, they sell; when retail investors panic they stop making fresh purchases (and most don’t sell). Most retail investors will never sell at a loss,” said Baliga.

Since April last year until July 2021, the advance-decline ratio has fallen below 1 (fewer stocks advancing than declining) on six occasions, only to bounce back in following months.

Some experts say broader markets (mid- and small-caps) are unlikely to revive in the next few months. And from hereon, the action is most likely to be selective with quality names across market segments seeing better investor demand.

“Historically, whenever the advance-decline ratio has fallen, it has taken a few months to go above 1:1. It is also dependent on how fast the recovery is after the fall. As the recovery after the March 2020 selloff was swift, the ratio also recovered soon,” said Jasani.