Volatile Markets - Time to be Cautious - it's happening everywhere!!

I have a strong feeling that it is time to turn cautious on the equity market (and stop dancing!). There is too much complacency about India / Asia being immune to the sub-prime lending crisis as well as the continued strong growth in the domestic economy and corporate earnings.

I feel this complacency is not warranted given:

1. The market's high dependence on foreign fund flows;
2. The mounting evidence that the economic growth is slowing down; and
3. The signs that the earnings growth momentum has peaked.

The complacency is not restricted to investors or TV commentators but, more worryingly, is also present among the policy makers and central bankers who feel that strong domestic growth is a given and are only fighting mythical inflation battles. I would like to make my readers cautious about:

• High dependence on foreign institutional investor (FII) inflows
• Slowdown in all economic growth indicators
• Sharp deceleration in exports
• Likely worsening of the current account deficit
• Slowdown in earnings: For the first time in several quarters the earnings of the Sensex companies were below expectation after stripping out the foreign exchange (forex) gain.
• This slowdown in the earnings momentum would become more visible from the second quarter onwards when the forex gains will not be there. A slowdown in the earnings growth would itself lead to a derating of the market's price/earnings (PE) multiple—investors would be OK paying 17-18x for a market growing at 30% but would they do the same if the growth were 15%? We discuss these factors in more detail.