Mumbai: Indian markets ended a four-day rally after a weak opening by European markets. The Bombay Stock Exchange (BSE) bellwether, the Sensex, which had gained 922 points or 5.7% in the last four sessions, lost 372.60 points or 2.2% to close at 16,572.03.

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The barometer touched a low of 16,318.39 points following a freak sell-off in Reliance Industries Ltd, India’s most valuable company, at 52-week low levels on BSE in a freak trade. According to the BSE website, the stock fell to an intra-day low of Rs840.55, down Rs204.50 before recovering most of the losses.

The freak trade did not affect futures prices on the National Stock Exchange. But its key index, the Nifty, fell below the 5,000 point level to end at 4,970.20, down 116.10.

European shares fell on Tuesday, as slowing Chinese factory output fuelled pessimism over global economic recovery. Banks slid after the European Central Bank said euro zone lenders face another wave of potential write-downs. The key benchmark indices in France, Germany and the UK fell 1.8-2.1%. According to analysts, the weak opening of European markets and the Dow Jones Futures, which dipped below the 10,000-mark, were the key triggers. “These are indications that problems in Europe are far from over. And local markets are taking cues," said Alok Agarwal, head of research, KR Choksey Securities Ltd.

Foreign institutional investors (FIIs), the key drivers of Indian markets, sold equities worth $1.98 billion, or Rs9,144 crore, in May. This is the highest monthly outflow since October 2008. Eighteen months ago, foreign investors had withdrawn at least $2.9 billion following the global liquidity crisis.

The fact that the outflows are the highest since then speaks volumes about investor confidence, said Agarwal of KR Choksey, adding: “There is a risk reduction happening among global investors and the FII numbers reflect that. Globally, risk appetite has gone down significantly. This is slowly turning into risk aversion. We have tougher days ahead."

According to analysts, the trillion dollar relief package announced by European governments may not be enough to address the risks posed by Europe’s troubled economies to the global economy.

“The EU-IMF (European Union-International Monetary Fund) package would at best ameliorate the event risks. The relapse of risk aversion could lead to a reversal of capital flows and...tightening of liquidity," wrote Dhananjay Sinha, strategist and economist at Centrum Broking Pvt. Ltd in a 27 May note. “The crisis reinforces our earlier bearish view arising from expected contraction in forward P/E multiples to 13x in H2CY10. We believe Sensex would hit 14,000. A double-dip scenario could potentially contract the multiples and earnings sharper-than-expected, thereby inducing further downside."

But economic data released this week shows strong growth in India, fuelling analyst expectations that flows will eventually return. The HSBC Markit Purchasing Managers’ Index (PMI), based on a survey of 500 Indian firms, surged to a 27-month high of 59 in May 2010 from 57.2 in April 2010, bolstered by steady growth in output, new orders and employment. The rate of growth had slowed in March 2010 and April 2010.

Given this, global investors will continue to pump money into India though things look bleak in the short term, said Sarabjit Kour Nangra, vice-president, research, Angel Broking Ltd. Kour said she is advising her clients to use the dips to buy good quality banking and infrastructure scrips at cheap prices. “Day-to-day developments in the euro zone continue to affect local markets. But, fundamentally, I don’t think we should fall below 15,800-16,000 levels on the Sensex." she added.

Graphic by Ahmed Raza Khan / Mint