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With time, the Indian equity markets have gained significant visibility and importance as global investors look to diversify their portfolio. However, even if there has some level of economic decoupling, there is no evidence of significant financial market decoupling. As a result, Indian markets are not immune to global market downturns.

This article discusses the outlook for the Indian markets in the foreseeable future taking into consideration both global and local factors. Further, the article discusses the NIFTY index level at which considering exposure to Indian ETFs would prove beneficial.

Very similar to all asset classes and equity markets, the Indian markets have also experienced significant volatility in since the financial crisis began in October 2007.

However, there is one very critical point to note in terms of the index level currently. As the chart below shows, the Indian markets experienced a significant upward move from its lows in March 2009. The NIFTY index nearly doubled in a matter of six months to reach levels above 5000 by September 2009.

[Click all images to enlarge]

Two years later, we are at the same level as we were in September 2009. I point out this factor before discussing the future outlook as it underscores the importance of change in investment environment (and strategy) in the current scenario.

Long-term investors, pulling money in the index would have got no returns (negative, adjusted for inflation) in the last two years. Therefore, investing as a medium-term trader is more beneficial in the current scenario than passive long-term investing.

The second important thing this data gives is the picture of the overall economic scenario in the last two years and the foreseeable future. If we try to understand the language of the markets, it is telling us that the overall economic scenario has been largely stagnant in terms of improvement in the recent past. Further, market participants do not foresee and significant positive development in the economy in the near-term.

On the contrary, one can make a case that we are worse off than we were in September 2009. There is no doubt that the global financial and economic system has more money floating around in September 2011 than September 2009. Still, equity markets fail to make any significant upside move.

In terms of P/E valuation, the Indian markets are trading in line with their historical P/E of 18. This does not suggest that we can’t see more downside in the foreseeable future. The Indian markets are still trading at a P/E valuation, which is at a premium over its Asian peers. Further, as mentioned above, the equity markets are still not decoupled from the rest of the world. As a result, any economic gloom in the Western world would negatively impact Indian markets.

The influence on Indian markets from global cues and foreign investor money is clear from the chart below. The Indian markets declined significantly from December 2007 to September 2008. This was a phase of tight monetary policy by the Indian Central Bank. However, the second phase of tight monetary policy period (December 2009 to now) has seen the Indian markets move sideways (including a bout of strong upside).

The first phase of tight monetary policy discussed above was associated with global market downturn. As a result, the Indian markets also declined. In the second phase of monetary tightening, the global markets were relatively stable and the same is reflected in the Indian markets.

Before discussing the near-term outlook for the markets, I discussed these factors as they would help me build a near-term outlook case for the markets. In other words, even if one expects the Indian economic growth to be steady, the equity markets might not necessarily reflect the same picture.

With these factors in mind, and the reasons discussed below, I believe that there is a higher probability of further downside in the Indian markets in the near-term. Therefore, in my opinion, investors can consider waiting in the sidelines before taking exposure to the Indian equity markets.

Another important thing to remember is that markets are a discounting mechanism. We have already seen some correction in the index in the recent past. The factors that might trigger further correction are discussed below :

1) Sharper than expected slowdown in the United States: While the probability of recession remains debatable, there is no doubt that U.S. economy is headed for a significant slowdown in the near-term (probably more than what policymakers expect). Any worse than expected downside in the economy will trigger further correction in equity markets globally

2) Slowdown in Europe: Business sentiment and overall economic environment remains depressed in the Euro region as well. Weak corporate profits coupled with weak overall economic activity will keep markets depressed in the near-term. The grave situation in Europe can be summed up by a recent statement by World Bank President Robert Zoellick – "The financial crisis in Europe has become a sovereign debt crisis, with serious implications for the Monetary Union, banks, and competitiveness of some countries."

3) Slowdown in China: The Chinese equity markets are indicating that all is not well with the economy. There have been predictions where economists are talking about possible crash in several sectors of the economy. Any such event or a meaningful slowdown in the economy will lead to significant correction in the Asian equities.

4) Dwindling Business confidence in India: The business confidence index has declined meaningfully in the third quarter reflecting bearish sentiments among the corporate. This is expected to translate into relatively weaker business growth and negative surprises for the markets in the foreseeable future.

5) Inflation remaining high: High level of inflation restricts any possible monetary action. Further, inflation is expected to remain at higher levels in the foreseeable future. This adds to the concerns for an economy already showing signs of cooling down

Buying Levels for Indian ETFs

It is difficult to assign specific targets for considering exposure to any markets or ETFs. However, the Indian markets are likely to see a further correction of anywhere between 10-15% in the next 2-3 months. Any meaningful downside like this can be considered for exposure to Indian ETFs for medium to long-term appreciation.

Some Prominent Indian Stock ETFs

1) iShares S&P India Nifty 50 Index Fund (NASDAQ:INDY) – This index fund returns correspond generally to the price and yield performance of the S&P CNX Nifty Index (the Index). The Index measures the equity performance of the top 50 companies by market capitalization that trade in the Indian market. Therefore, exposure to this fund gives investors the benefit of returns from the top Indian listed entities

2) WisdomTree India Earnings Fund (NYSEARCA:EPI) – This fund is not an index fund. However, the fund seeks to track the price and yield performance, before fees and expenses, of the WisdomTree India Earnings Index. The fund has exposure to some of the largest listed companies in India and has the potential to outperform other indices in a general market uptrend scenario

3) PowerShares India Portfolio (NYSEARCA:PIN) – PIN investment results correspond to price and yield of the Indus India Index. The Indus India Index is designed to replicate the Indian equity markets as a whole, through a group of 50 Indian stocks selected from a universe of the largest companies listed on two Indian exchanges. Therefore, another ETF, which gives investors a sector diversified exposure to the largest listed companies in India

In conclusion, any meaningful correction in the Indian markets will serve as a good opportunity for medium-term investors to consider exposure to some attractive Indian ETFs.

Source: Indian Equity ETFs: An Attractive Buy On Further Market Correction