Markets across the world have entered 2009 with an unprecedented amount of uncertainty, volatility, losses and, above all, fear.

The concern of what the New Year will bring in terms of returns from financial assets, especially equities, is paramount on every investor's mind. To find the answers to how Indian equities will perform in 2009, we should take a look at 2008 and assess why this turmoil started in the first place.

The problems started with defaults in the US housing markets, which later spread to the entire financial market. Losses in real estate-related instruments forced institutions to sell assets across the board in all markets to meet liquidity challenges --  assets related to real estate became almost illiquid.

The problem intensified as some of the institutions were highly leveraged, which resulted in a free fall of prices for most financial assets, including equity. The tight liquidity problem made its way to the real economy -- production and consumption started getting affected. The result: a bleak global economic outlook for 2009.

Economy

As we move into 2009, the baggage of excesses created in the last few years will continue to haunt us. We haven't yet totally adjusted to the ripple effects of the sub-prime crisis. Also, the ongoing process of de-leveraging will continue to put pressure on all financial assets for some more time.

We believe that the global economic condition will worsen before it starts improving. The good thing in this turmoil is unprecedented response from central banks and governments across the world, which helped avoid any kind of systemic failures. Experts believe that timely intervention will make the landing safer and help early recovery.

The case of Indian equities

Indian markets fell in line with global developments and lost in excess of 50 per cent in 2008. The price damage is significant in some sectors. For example, all stocks in the BSE Realty Index have lost in excess of 80 per cent (except Akruti City) since January 2008.

The correction has been so severe that with the market cap of DLFin January 2008, you can now buy all the companies, including DLF, in the realty index two times over, and still be left with spare cash. The realty sector is not the only one feeling the pain.

Stocks have fallen across the board, and we don't have a single sectoral index in green. The FMCG Index has shown some resistance, but it, too, has lost close to 13 per cent since the beginning of 2008.

The way ahead

The Indian equity market will continue to track global developments in 2009. In 2008, market participants learned that there's nothing called decoupling of financial markets.

Apart from global events, domestic factors, such as earnings growth, GDP growth, and the general elections -- the biggest event of the year -- will also play their part.

Says Nilesh Shah, CIO, ICICI [Get Quote] Prudential Asset Management: "The third quarter results will be disastrous and the fourth quarter results are unlikely to show any great improvement either. We believe that markets in initial stages will be range bound, trying to find a bottom. Recovery will not be sharp as there has been collateral damage in the system. But we expect decent returns from the current levels."

At the moment, it is extremely difficult to put figures for sales volume, margins, interest rates, and currency risk for Indian Corporates. This, in turn, is not allowing analysts to calculate profits for the coming quarters.

However, some positive developments are not getting counted due to wider negative sentiments in the market. Says Sanjay Shina, CEO, DBSC holamandalam Asset Management: "The outlook for 2009, in terms of commodities, is of softer prices. The peak of interest rates is behind us and it should only go down from here. The combination of these two factors means that the earnings outlook is far more optimistic going forward compared to what it is in retrospective terms."

Apart from global events and the domestic earnings outlook, which will affect investors' sentiments, the outcome of the general elections will play a major role. If the verdict is fractured, it will be difficult for the government to focus on development as it will end up spending more time on its survival.

Analysts believe that the outcome of the assembly elections held in 2008 had a strong message -- development. This will encourage the current government to push speedy implementation of projects during its remaining tenure, and this will have a positive impact on the broader economy and the markets.

Investors entering the markets at this stage should have at least a 3-year investment horizon. We believe that the worst is not yet over and bad news will continue to flow in for some more time.

The first two quarters of 2009 will be crucial for the markets as well as the economy. Markets will start recovering with the first sign of stability in the global economy. However, don't expect it to bounce back to the January 2008 highs in a hurry.

The global risk aversion is likely to continue for some more time, and the excess liquidity, which was there in the system till early 2008, is not available anymore. Also, we will not see the kind of liquidity we saw in last few years.

The large government deficits, which the developed markets are creating for bailouts and stimulus packages, will result in a supply of sovereign bonds, which will suck liquidity from the system.

The global liquidity situation is not allowing the money to flow into equities and forcing the institutions to sell, either to meet redemption pressure or to generate cash for their own survival.

At the same time, individuals and institutions, which have cash, are staying away from the market as they anticipate further corrections and are waiting to buy at lower levels.

In such a scenario, stock selection becomes extremely important because now prices will be based on the earnings expectations and not on PE expansions.

What to do

• Have a minimum of a three-year investing horizon
• Buy systematically and in small quantities
• Book your losses on stocks & sectors performing poorly
• Don't fall into the value trap  --  a cheap stock is not always a good buy

Quick Fix

I have stopped putting in money in the market and am now looking at selling my shares. Is it a good decision?

If you have invested in a fundamentally sound stock, there is no reason to worry about volatility. But, if you are holding stocks from sectors (say realty) which show little potential to grow in the foreseeable future, it would make sense to trim your losses instead of waiting for a recovery. Monitor the market movement and exit when there is a pull-back rally.

Will market go down further?

It is hard to say if the market will go down further from the current level. But, a long-term investor need not be concerned about how much the market will fall. A good strategy would be to start buying fundamentally sound stocks in small quantities. Invest with a long-term horizon.

Is it okay to rely on investment Tips given by brokerages?

When the markets are on a bull run, the rate of error on any tips or recommendations is normally low. However, with the markets on a bearish mode, any tips should be backed with your own research. Spend as much time as you can on understanding the stock that you are going to put your money into.

Will companies that have shown a negative year-on-year growth recover in the near future?

The economy is having a negative effect on many sectors, such as real estate, information technology and cement. It is difficult to say how long these companies would take to recover, one can definitely say that 2009 will be a tough year for many. Invest in sectors that are, to a large extent, delinked from such economic upheavals.