Indian equity markets tanked in the first hour of trade on Friday, part of a steep decline in markets around the world after renewed fears that the global economy is unraveling and headed towards a double-dip recession.
The ongoing carnage around the world is the worst since February 2009, just before investor confidence bounced back from the lows of the financial crisis. Investor confidence seems to be plunging again, as the Chicago Board Options Exchange’s volatility index spiked above 30 for the first time since March.
How bad is it? Financial blogger Barry Ritholtz has pointed out that the S&P 500 has had its 27th worst day since January 1950. Twenty one of the worst 40 days were in 2008 and 2009, as things fell apart after the collapse of Lehman Brothers in September 2008. The market decline on Thursday was worse than the one we saw the day after Lehman crumbled to dust.
The economic news around the world is decidedly glum. The situation in India adds to domestic worries. Corporate earnings could be under pressure on growth worries and recent statements from policy makers suggest that the battle against high inflation could be a long one. Equity valuations could get hit as lower earnings will have to be discounted at higher interest rates.
A lot now depends on what happens in the next few weeks. Most Western markets are already down more than a tenth from their highs this year, or in a correction zone. The big questions now are: will the correction enter into a bear phase as well and will the current global slowdown actually end up in a double-dip recession?
A lot now depends on the policy response. Europe and the US are --- for different reasons --- committed to fiscal austerity to repair their public finances. The burden of action will thus be on central banks, and there is already a growing buzz about a new round of quantitative easing, aka QE3. A note of warning: the current economic worries show that QE1 and QE2 have done little to sustain the Western economic recovery but left behind a legacy of higher commodity prices and inflationary pressures.
Early morning trading in India and China showed that these markets have been relatively more resilient, though Europe had not yet opened for Friday trading at the time of writing (at 10:00am). There are two possible reasons. First, these markets have underperformed for much of this year and hence are
seeing a more modest correction. Second, the main problem in these two countries is inflation, so a growth downturn in the West could deflate commodity prices and reduce domestic price pressures, a huge positive for markets here.
But the next few weeks could be very choppy.