The year 2011 has so far proved to be painful for world equity markets, with all major global indices witnessing negative returns. A spreading debt crisis and the anticipation of a recession in the developed world have ignited negative sentiments in markets across the globe. Growth stories in the developing world have not been able to resist the sell-offs, and most of them have witnessed a double digit decline in the Year-to-Date 2011.

Indian equity markets, which have already been under performing on  domestic issues like high inflation, rising interest rates, corruption issues impacting government decisions, increasing fuel subsidy burden, etc., declined further on negative global sentiments.

The Indian market is among the worst performing emerging markets, with an 18.3% fall Year-to-Date, and the Chinese and Brazilian markets also declined by 7.2% and 21.6% respectively. Currently, the Sensex is trading at a P/E of 15x, at a discount of 17x to its long-term average, but at a premium to the Chinese and Brazilian indices, which are trading at 14.3x and 8.3x respectively.

However, India is still among the fastest-growing emerging markets, with an 8% GDP growth and less dependency in terms of exports to the developed world. On the other hand, other emerging economies are expected to grow at a relatively slower rate in the current year, at an average 6.5%. We think that India should outperform most of its peers in the longer run. The Q1 FY12 results of Sensex and Nifty companies witnessed strong revenue growth, averaging at over 20%, but their average net profit grew in single digits. High interest rates and raw material prices have hit bottomline growth. Commodity prices have softened a bit, but the impact of high interest cost would continue in the coming quarters, hurting interest rate-sensitive sectors like banking, automobile, real estate, construction, infrastructure, etc.

Going ahead, key triggers for the market would be the softening of inflation which influences the RBI decision on rate hikes, the movement in crude prices, speedy policy decisions by the government and measures adopted to resolve the debt crisis.

Despite aggressive rate hikes by the RBI, inflation continues to be buoyant, with WPI at 9.2% for July 2011. Though there has been some moderation in WPI for July, it is still above the RBI’s revised level of 7%. We believe that inflation will continue its buoyancy till December 2011, which might force the RBI to go for another rate hike. However, with the US debt crisis, Brent crude has fallen below USD 110, which will help in cooling off inflation. We expect interest rates to start cooling off in 2012.

Standard & Poor’s move to downgrade US creditworthiness has hit the global markets. Unless there are some fundamental reforms to deal with this, the the uncertainty is likely to continue.

Investors are rightly worried about European debt problems and global economic growth. In the current environment, we are positive on the sectors with domestic consumption story and on those that are less sensitive to interest rates. According to us, interest rate-sensitive sectors will not outperform in the short-to-medium term, until the RBI hits the pause button on further rate hikes. Besides, in such a volatile market, we advise investors to consider low-risk investment opportunities like risk arbitrage and special situations arising out of buyouts, delisting, open offers, etc