Falling liquidity in small cap and mid cap stocks

2008 has been an extremely volatile year for the equity markets. Along with market fluctuations, there has been a fall in the liquidity for individual scripts. This is more pronounced in the case of mid cap and small cap companies.

The Bombay Stock Exchange (BSE) has seen a fall in the turnover in both cash and equity segments. This has hit small investors hard as often small companies are listed only on the BSE and not on the National Stock Exchange (NSE). For several companies the turnover is below thousand shares a day, making it difficult to buy/sell even small quantities.

This hits small investors the hardest. Large investors like mutual funds, insurance companies, FII’s tend to stick to the large companies anyways. Small investors typically seek value in smaller companies and here they are facing a liquidity crunch.

While purchasing shares of a company, the liquidity has always been a criterion. In the current market scenario, it gains more importance, and small investors are advised to keep away from shares with very low liquidity. Typically, shares in the A group have more liquidity and they could form the first sub set from which companies are picked out.

While picking stocks outside the A group, the following guideline could be typically used – An investor should be able to buy/sell shares worth at least Rs 25,000 in that company without difficulties in the day. It is important to have a benchmark in terms of value as the market price of the share might vary from Rs 2 to Rs 10,000.

In a nutshell, ideally consider shares which are traded both on the NSE and BSE and have atleast a minimal level of liquidity, so that we can buy/sell them without having to pay a liquidity premium.

Mortgage conditions 'set to worsen'

Home owners are being warned that they will find it even more difficult to get a mortgage in the next few months. The warning was issued by the Council of Mortgage Lenders as it released figures showing mortgage lending had dropped almost 30 per cent to the lowest July figure since 2002.

The latest decline stands out because July is typically one of the busy months for mortgage lending. The CML blamed the shortage of mortgage funding and slower demand among home owners for the worsening conditions. Bob Pannell, CML head of research, said: "In the absence of fresh interventions from the authorities, mortgage lending activity is set to worsen in the second half of 2008."

He explained there is a "dampening of consumer demand due to tightened lending criteria, declining house prices and pressures on household finances from higher food and energy costs". While gross mortgage lending is down 27 per cent from July last year, it actually increased by 5 per cent the previous month to £24.8 billion in July. But Mr Pannell added: "While there was a small month-on-month increase in activity, it represented a notable decline from a year ago.
This continues the weaker picture seen in June and points towards the more subdued levels of lending we are likely to see in the second half of 2008."

His comments come just a day after Kenneth Rogoff, chief economist to the International Monetary Fund between 2001 and 2004, told an audience in Singapore that "the financial crisis is at the halfway point, perhaps."

Now an economics professor at Harvard University, Mr Rogoff said. "We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks."

The CML said its mortgage lending figures - based on completions - are expected to get worse because the Bank of England said last month that mortgage approvals had plummeted by more than two-thirds in a year.

Mortgage approvals were down from 41,000 in May to just 36,000 in June - the lowest level since records began in 1993, the bank said.