Increased risk

The sudden flight to safety from emerging markets last week reminded investors once again of the risks looming over them. High oil prices, fears of inflation in the US and rising bond yields rattled the markets, triggering a flight of money out of assets perceived to be more risky.

That led to more money going to US equity funds rather than to emerging market funds, and US bonds rose while emerging market bonds fell.

With foreign fund inflows being the main driver of the markets in the developing world, it's no wonder that these markets shuddered in unison.

Back home, two days of net sales by FIIs were enough to force the Sensex down by 3.7 per cent from its highs.

Some global indicators do suggest that market risks are rising. The VIX, or the market volatility index on the S&P 500, is at a multi-year low, suggesting extreme complacency.

CSFB's Global Risk Appetite Index is in the euphoria zone. But one needn't look at esoteric contrarian indicators to prove that risks are indeed rising in the stock markets.

For a couple of years now, the markets have been in a "sweet spot", with low interest rates, strong earnings growth and relatively low valuations.

All these trends are turning for the worse, at a time when global liquidity has started to contract. Logically, the markets should have a more difficult time ahead of them.

The risks are obvious""high oil prices and rising interest rates in the US. Under these circumstances, nobody can blame market players for wanting to hedge risks, and that is true for the FIIs in the Indian market as well.

The fact that FIIs have been net sellers in the futures segment at the same time that they have been buying in the cash market is therefore no surprise.

This is not to rush to conclusions about a bearish trend setting in. First, although economic growth may slow, the overall tempo is likely to be more or less maintained for some time.

As a matter of fact, the OECD leading indicator is now showing a slight upturn. Second, the latest data from the US treasury show that America continues to attract more than enough foreign funds to comfortably fund its deficit.

Third, while oil prices are high, structural changes have resulted in a trend towards lower inflation. Fourth, the feared Chinese slowdown is yet to materialise.

The Indian market has an even higher level of comfort, because of continued growth, on the one hand, and the discovery of the India story by international investors, on the other.

Inflows to Asia ex-Japan funds continued to be robust in the week to March 16, with almost a third of the flows going to India funds, despite a net withdrawal from all emerging market funds.

There are also signs that the retail investor has finally started entering the market.

Stocks should also benefit from earnings growth. The conclusion would seem to be that while there could be a change in market sentiment, price trends will be uncertain amidst increased volatility.