In the dynamic universe of stock trading, the past few months have brought an unsettling wave of fluctuations in China's micro-cap stock market, particularly highlighted by the plunge of the Wind Micro-cap Stock Index, which experienced a staggering 20% drop within just one monthObservers have noted that the index has culminated a year-to-date loss of approximately 24.68%.

However, in the wake of the Dragon Boat Festival, there seems to be a semblance of recovery with a number of listed companies in the A-share market managing to eliminate their unfavorable designationsBy June 12, the Wind Micro-cap Stock Index indicated a rebound of 3.02%, suggesting that the tumultuous “crisis” might be experiencing a pause.

Current discussions point towards understanding the origins of this crisis.

Breaking down the timeline of events throughout the year, the micro-cap stocks have witnessed three distinct waves of tumult

The initial shock occurred early in the year as trading structures within this segment demonstrated poor performance, leading to a cascading collapseThis period was catalyzed by external factors, including significant trading events related to margin financing and speculative investments.

Next came the events following the new “National Nine Articles” policy in April, where market misunderstandings around delisting standards triggered yet another sell-offConcurrently, fears surrounding annual reports and volatility in quarterly performances further exacerbated the drop in micro-cap stocksA third wave was brought on recently as regulatory bodies intensified scrutiny and communication with troubled companies, leading to an uptick in the number of Special Treatment (ST) stocks.

CITIC Construction Investment Securities posits that the underlying reasons for this downturn are largely rooted in the cyclical rotation between large and small-cap stocks

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Factors such as a slowdown in new capital inflows and the tightening of regulatory measures regarding delisting culminated in a significant pressure on the micro-cap sectorWhile regulatory pressure has been viewed as a major catalyst for market declines, it is often underlined as merely a triggering factor in the broader context.

Yixiaobin, the Director of Equity Investment at Shunshi Investment, articulates that severe regulatory measures combined with liquidity shortages are primarily to blame for this micro-cap turmoilIn an environment dominated by limited capital resources, the stern investment ideology pushed forth by regulators harshly impacts the micro-cap arenaWith a shift in market risk preferences, investors are less inclined to shoulder high risks, tending instead to hoard capital in stable, low-valuation stocks that offer significant dividends

Furthermore, institutional adjustments have facilitated the swift decline of micro-cap stocks, where the consequences of market cap delistings are felt profoundly.

Yuchao, the Chairman of Qingdao Anzhi Investment, also highlights the diminishing value of shell resources under stringent regulationsWith no substantial reassessment of China's economic outlook, market risk appetites remain tepid, leading to a consistent downtrend in small and micro-cap stocks amid increased volatility.

Statistics reveal that 99 new companies in the Shanghai and Shenzhen markets have currently been subjected to ST or *ST designations this year aloneAmong these, 44 companies are classified as ST while 55 have received the *ST designationAltogether, there are currently a total of 169 listed companies under the ST classification in these two markets.

In response to the growing concerns over these trends, Guo Ruiming, the Director of the Department of Listed Companies at the China Securities Regulatory Commission, addressed the media on June 6 regarding the ST and delisting situations

He elaborated that the purpose of the ST and *ST regulations is to provide timely warnings to investors regarding the associated risks of listed companies while also allowing firms meeting specific criteria to apply for removal from the designation.

Further, Guo revealed that this year, 33 companies have met delisting requirements, with 22 facing delisting due to inadequate market capitalizationThe market mechanism of 'survival of the fittest' is gradually taking shapeFor 2023, a total of 47 delistings are anticipated, with the new delisting regulations establishing a buffer period, indicating that a surge in delistings is not imminent.

Looking ahead, there seem to be signs of recovery in the micro-cap stock sector.

Post-Dragon Boat Festival, several A-share companies have managed to lift their delisting warnings, hinting at a gradual stabilization in the micro-cap sphere

As of June 12, the Wind Micro-cap Stock Index has reported a commendable recovery with a 3.02% increase.

Reports show that as of June 11 and 12, nine companies including ST Shihua and *ST Fujiji have announced the removal of their delisting risk warningsIn total, nine A-share companies have successfully shed these negative designations.

The question that remains is how the future of the micro-cap market will unfold.

According to financial commentator Guo Shiliang, the radical downturn in micro-cap stocks correlates directly with stringent new delisting regulations and tightening market liquidityAmidst these developments, there lies the possibility of finding undervalued stocks that have been unjustly punishedMicro-cap stocks that are in fact showing robust growth potential may, after significant dips, provide lucrative opportunities for price or valuation recovery.

Xia Fengguang, a fund manager at Rongzhi Investment, emphasizes that the value of listed companies is not strictly bound by their capitalization

What holds paramount importance is their ability to generate profitsIn developed markets, large-cap stocks may exhibit superior liquidity; however, small-cap stocks often exhibit higher volatilityThere are numerous small-cap stocks that are undervalued yet possess strong growth advantages and remain worthy of investment consideration.

After enduring six months of steep declines, certain quality small-cap stocks may have their valuations return to acceptable levelsProvided their growth trajectories can withstand scrutiny, these stocks may be poised for a rebound in valuation.

Yixiaobin expands on this notion by asserting that opportunities do remain in the micro-cap space, yet deep fundamental analysis is paramountIt’s essential to look beyond mere market capitalization to discern potential valueInvestors should scrutinize industry prospects, the competency of management teams — gauging their technological expertise and competitive advantages, alongside ensuring robust financial health.

Thus, uncovering these "golden pits" — opportunities masked by broader market trends — is a challenging endeavor