Only bonds and gold gained, clearly revealing a massive flight to safety by investors. In India, the 10-year government bond yield hit a three-week low of 8.09%.

European market indices such as the CAC 40 (France) and DAX (Germany) dropped by more than 5%, which is extremely high for developed markets.

The dollar gained against almost all currencies (again, a result of the flight to safety), except the yen.

The yen gained sharply on Monday as investments funded at low interest rates in Japan are now increasingly being unwound and funds are flowing back into the country.

All this is a sign of increasing risk aversion. If the current trend continues unchecked, it could well be a race to the bottom as far as the equity markets go.

With equity markets across the world trying to figure out how bad the global credit crisis could get, the news on Monday that Iceland is trying to salvage its overleveraged banking system didn’t really help.

Also See Losing Ground (Graphic)

South Korean authorities asked the country’s institutions to raise funds by selling overseas assets, as did their Icelandic counterparts. Already, a number of Western financial institutions are selling assets in the less liquid emerging markets to improve their own liquidity.

As one economist put it, “It’s ironic that Western institutions are looking to less liquid markets to shore up their liquidity currently."

The upshot is that the disproportionately large trade sizes of these investors severely hit asset prices, as is being witnessed in markets such as equities in India.

If the trend continues, things would get much worse. The only way out seems to be a concerted move by central banks across the globe to shore up liquidity by cutting interest rates.

Meanwhile, the Reserve Bank of India cut its cash reserve ratio—which determines the amount of money banks have to keep with the central bank—by 50 basis points, which will partially improve the liquidity in the domestic market for banks.

One basis point is one-hundredth of a percentage point.

Inter-bank call rates, or the rates at which banks lend to each other, are currently rather high at 11-11.5%, and the additional liquidity should result in a reprieve for bank shares. Other sectors would benefit only at the margin, if at all.

The decision of the Securities and Exchange Board of India, or Sebi, to remove the restrictions on investments through participatory notes, or PNs, may also not stem the selling in the markets.

PN-issuing brokers were anyway operating below the 40% limit prescribed by Sebi, and hence it is unlikely that there will be a surge of liquidity into the markets. If anything, the move would help improve the sentiment on the street.

Q2 looks firm; numbers seem to show economy is still doing well

Earnings season is around the corner and brokers have started to work out their estimates for the July-September quarter.

The latest macro data seem to suggest that while the gloom is deepening, the quarterly results may not be all that bad.

Recent data on exports, for instance, show that they grew at an annual rate of 26.9% in August.

While that was less than the 31.2% export growth in July, it is high given the circumstances. It is easy to forget that export growth was 12.9% in May and 23.5% in June.

Non-oil imports, a proxy for the strength of domestic demand, rose by 39.6% year-on-year in August, compared with 38.7% in May.

We’ll have to see whether gold imports may have contributed to the rise, but in spite of that, the growth in non-oil imports is still very high.

Oil imports also rose, despite the fact that international crude oil prices had started to fall since the middle of July. In volume terms ,too, oil imports in August were higher than in July.

In short, the numbers seem to show that the economy is still doing relatively well, a conclusion reflected in the purchasing managers’ index, or PMI, survey for September.

Broking house Motilal Oswal Securities Ltd estimates year-on-year growth of profit after tax (PAT) for the Sensex companies at 17.1% for the September quarter, while Citigroup Inc. puts it at 12.7%.

Compare that with Citi’s Q1 growth estimate of 10.4% and Motilal Oswal’s estimate of 15.6%.

One reason for the higher estimates this time is that the Sensex composition has changed. Nevertheless, actual PAT growth for the Sensex companies in the June quarter was 23.8%, well above the pessimistic estimates.

But there’s a big disconnect between estimates for the second quarter of FY09 and estimates for the full fiscal.

For instance, Motilal Oswal has an estimate of 23.9% growth in earnings for FY09, while Citigroup puts it at 18.7%.

There still seems to be hope that activity will improve rather than deteriorate as the year progresses. That is very unlikely.

That would also be true of Motilal Oswal’s even more optimistic estimate of 23.9% earnings growth for the Sensex companies in FY10.

Angel Broking Ltd, which has an estimate of growth in diluted earnings per share (EPS) of 12.7% in FY09 (a rise from Rs853 to Rs961 in Sensex EPS), also estimates that EPS growth will be higher, at 17.6% (with EPS of Sensex companies rising to Rs1,130) in FY10.

The continuing optimism implies that more earnings downgrades are in the offing.

But downward revisions in earnings are just half the story. At the moment the trailing Sensex price-earnings multiple is around 15. It had gone down to as low as 12.26 in October 2002, during the depths of the last downturn. And that was just a common bust compared with the disaster unfolding before our eyes.

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