Extreme pessimism may push markets down: Investors advised caution

There is extreme pessimism in the markets, despite US equity indices making new highs. In my last post, four weeks back, I had anticipated the markets to correct to the level of around 5600 on the Nifty. The market has decisively breached the 5600 mark recently and is not showing any signs of a recovery soon. The underlying pessimism in the markets is a result of the following factors:

• India's economic recovery is still illusive. In fact fresh data is suggesting a further slowdown in growth momentum. Inflation is not coming down to reasonable levels and the Current account deficit (CAD) has blown to 6.7% of the GDP. Despite a falling rupee our exports continue to stagnate. There are serious supply side bottlenecks in core sector growth. Policy paralysis is making a heavy negative impact on the Infrastructure, Power & Mining sectors. New investors are shying away from investments in Indian projects. Even the FII flows are slowly turning negative.
• Political Uncertainty is likely to intensify in the days to come. This may lead to postponement of important economic decisions. The announcement of early General elections could dampen the market sentiment further.
• The news flow from Euro zone continues to caste its shadow on risky assets. The Cyprus issue could escalate  to a full blown crises for the Euro zone. There are other concerns too. North Korea continues to be 'Joker in the pack'. It has the capability to disturb the global equation, and may lead to military tensions with the west.

In the above scenario, the short term outlook for all risk assets (Equity, Bonds & Real estate) does not seem to be promising. We could soon see a panic situation in real estate markets as the liquidity is becoming tight. We could also  see a substantial fall in equity indices from the current levels. Equity markets could fall another 10% from the current levels and could stabilise around 5000-5200 on Nifty and 16500-17000 on the Sensex. A sudden declaration of war (by North Korea) or dissolution of Lok Sabha could have a knee jerk reaction on the equity indices which could take the Nifty to sub 5000 levels for a short while. If this happens it would be a really opportune time for investors to buy, as the indices would recover from their lows quickly. Investors are advised not to panic in the volatile environment and keep investing in front line  equity stocks on declines. Any short term bounce from the current levels towards 5750 on Nifty will be a good opportunity to book some profits & trim short term losses. An early election will be positive for the long term revival of the Bull market in India. If that happens we could see a sharp turnaround in equity markets in the 2nd half of FY 13-14.