For any of us to understand what happened in the equity market, we need to see what happened over the last 5-6 years in the USA.

Since 2007 the US has been using a very unconventional kind of a policy. From a base of having US $ 900 billion in 2007, it let the base shoot up to $ 3.6 Trillion – even tipping slightly over! All this liquidity was provided to shore the balance sheets of the American banks.

However the Central banks can only decide the quantum of funds, money finds the best markets to go to. So the money went to countries with far higher yields. Think: Brazil had interest rates of 11.3%, India and Indonesia were also in double digits. Compared to this the USA had yields of 1.2% p.a.!

When this avalanche hit these markets, we all started believing that we had done something to ‘deserve’ this cash flow (as individuals do we not rationalize our sky high BFSI driven salaries?). So suddenly Emerging Markets found that interest rates could be kept low (to please the industry), and sustain high growth (to please the Foreign Investors) without worrying about controlling government spending. Wow! that was utopia.

Like Taleb says when we got used to this low interest regime, we started thinking this was PERMANENT. Sadly it is not so.

This lesson was brought home when the Fed said ‘our printing machine needs some rest’.

The world wide reaction – somewhat predictable was – the easy arbitrage money had to go back. So it started going back from the markets where it had come – South Africa, Brazil, India and Indonesia. Obviously other countries have been hit too, but countries with high CAD have been hit worse.

In the meanwhile Central Banks too have reacted differently – Brazil has announced many currency swaps. India has imposed curbs on imports, put restrictions on Forex remittances, etc. What is to be remembered is unlike in 1997, EMs are in a better position to react. India has a cash reserve of US $ 300 billion to play with. RBI also has gold worth about 30 billion US $.

However the outflows will happen. If I had a clientele in the US, I would be advocating a ‘avoid EM’ – kinda philosophy for the next 3 months at least. So expecting inflows is out – outflows may not have abated.

So it is really difficult for Indian markets to go up – in fact we could see interest rates go up first.

RBI is not the smartest when it wants to surprise the market. Most of us know that the UPA Government at the Center could not care – and they have pushed the Food Security Bill – a license for the smallest UPA worker to claim credit and a part of the cash.

No, the markets do not look rosy at all.

However, markets may have discounted all that I have written – nothing of this is new – so what will the market do next?

Million $ question. Let us see.