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Shankar Sharma of First Global said investors need to be cognizant of changing market conditions. "The global bull market that started in 2003 seems to have ended. The final capitulation has not happened as too much noise out there. There is no point looking at Sensex PEs as one is not getting value stocks to buy," he told CNBC-TV18.

He feels that trade is no longer in equities and sees value in other asset classes. FY09 estimates are very optimistic, he said. "However, we are likely to see lower numbers. India does not have legs to sustain 9% growth. Even GDP is heading downward. The political situation is also a concern. We see elections this year. The risk reward is not favourable, while the downside may not be limited."

According to Sharma, China and India are likely to underperform while Thailand is likely to outperform.

The US is heading into a very bad recession like the 1920s, Sharma said. "Large write-downs can erode financial wealth in the US. The Fed's move is not enough to stop the credit contagion. and some banks can go under. Petro dollars may also not come back."

Excerpts from CNBC-TV18’s exclusive interview with Shankar Sharma:

Q: When we spoke to you last, you were very circumspect about the market. Do you still see more downside from here?

A: It depends on what view you want to hear. You want to hear the truth or you want to hear politically correct comfortable sounding nonsense. I can give you both answers.

Q: We want the truth.

A: Let us talk the politically correct line and then we will come to the truth. The politically correct line is to state that look the world is not coming to an end. Valuations are cheap and markets had become a tad frothy. Now, they have been knocked back 20-25%. Hence, we are in good shape there. India still is a secular growth story and stuff like that.

The truth is that we think the US is headed for a very severe recession. My nightmare scenario is that the US heads back to 1929 kind of situation. The entire financial system is bust. People talk about write-offs being in the range of USD 250 billion or USD 400-600 billion, and the highest probably is at trillion dollars and they say it is not a lot of money for their economy and a market that’s like whatever USD 10-12 trillion - may be their size of the economy may be little bit here or there depending on which value the dollar you take but of that order. The point is that the entire net worth by and large of the US financials as an aggregate set is no more than USD 300 or 400 billion.

If you take write-offs of USD 250 billion, then you are wiping out 60-70% of net worth. You take hits of USD 400 billion plus. The entire US financial system is bust. That is a matter of fact. The problem in finance is that you basically support a large amount of liabilities on a very small amount of equity. When that equity goes, the liabilities get pulled. When that situation happens, then you have a run on banks.

Then, you have run-on investment banks that are largely funded out of short-term debt like commercial paper, etc. Those liabilities can disappear overnight. So, even though you might have liquidity, at least the money in the bank is actually borrowed capital.

You are going to see a situation wherein you will see a bank or two really go under, if not more. I would attach an 80-90% probability of that thing happening.

So, maybe the liquidity taps that have been assumed to be there because of the petrodollars may not be that amenable this time around.

So, what happens is you have bankruptcies in the financial sector. That affects credit to the marketplace and credit to consumer. It has a whole cascading effect.

I do not think the Fed's blunt instruments are enough to stem that particular rot. Once that happens, you have the complete contagion spreading to other parts of the world.

Coming to India, you have a problem even locally. It has been our view for the last six months that India is going to slowdown big time. This economy simply does not have the legs to keep running at 9% for a very long period like China.

The reason for that is that we are underinvesting in the building blocks of economic growth. We are taking growth as a given, while not doing enough to make the growth sustain. The last round of numbers that have come in confirm our view. You are looking at GDP growth slowing down fairly substantially.

The other thing is that we do not believe in putting out GDP estimates. Sitting in Nariman Point, how do we know what IIP numbers or agricultural growth numbers or services sector growth is going to be. Anybody who does that is frankly just shooting the breeze.

Our view as a house is that you can only talk about the directional trend in GDP growth. Our sense is that it is headed sharply down. So, you have a domestic problem on GDP growth.

Q3 numbers have not been good. On top of that, the mother of all problems is the politics. Let us assume in the best case or the worst-case, depending on which side you are on, the elections are held on time, which is April or May next year. That means you have uncertainty from today. That has been a complete dampener on equity market performances historically. Once it is out of the way, then that is another matter. But till it is there, you cannot expect the upsides to be breached.

So, you have a classical situation of global problem and local problem. Political issues will keep rearing their head up and we don't know the mosaic of the government that emerges even after the elections. All those things put an absolute cap on the upside and the downsides are not capped. So, the risk reward is very unfavourable.

Q: What do you think, has the final capitulation happened or do you think there is more blood to be spilt?

A: No, I do not think the final capitulation has happened. I think looking at everyday FII figures and F&O-long, F&O-short, there is so much noise out there. You have to filter out the noise that is a crux to investing. There are just too many data points that cause a lot of confusion, but actually add up to nothing. So looking at micro numbers on day-to-day movements or what mutual funds bought-sold, FIIs bought-sold is all a complete waste of time.

The fact of the matter is that yes, the markets will pause here, probably take a breather before they resume their downward journey and I say this with the simple logic that if the US were to enter into a recession, it is not going to get over in twelve months time. It could be like a year and a half maybe a two-year recession. How on earth can India stand out and have a bull market? Then we are saying that we are like the Mohammad Ali of boxing. We are nowhere even close to that situation, forget about India, China is going to slowdown this year. The trade is no longer in equities for a Brazilian trade or a Mexico trade, those are the trades out there or maybe a Thailand, which we think is going to be the standout performer this year. India is not the trade for the year, let us be clear about it on a global strategy basis.

Equities are not the trade for the year, fixed income is, to some extent some parts of the commodity markets are, but definitely not equities.

It's years of living beyond your means; From the time I started following markets, which was 28 years back, I have always read how leveraged the US consumer is, how the deficits have been unsustainable, on practically all parameters, and I kept wondering through the last 28 years, that can this keep carrying on. Finally the point has been reached, where you can't carry a set of deficits along for a long time. At some point, that’s got to give and the currency is showing you that pressure. The US has lost the confidence of the world, and the US carried on because of confidence, it wasn’t because of fundamentals, it carried out because the world believed the dollar was a good currency to hold on to and the US economy would somehow come out of it.

They are getting deeper into it, so I see no reason why the US can’t go into a recession, which can parallel recessions of the previous century. In that situation if we just keep sitting here and hoping that India has a bull market, or resumes the bull market, then we are not analysts anymore and we are completely in the realm of wild fantasies.

Q: Last time you came here, you scared a lot of people by saying the index could go to 4 digits, you still think there could be that much downside this year?

A: Did I say that?

Q: Yes you did.

A: I think that was 'we will get close to 4 digits'. And if you are talking Nifty we are already in that kind of range, aren’t we? So my sense is, I am not a believer in putting target prices, it's just a trend that is important, because that’s the important thing in investing. We think the trend is down, and it’s not going to resume its upward journey anytime soon, so pick a number from here until the high four figure numbers, you could be reaching those levels. I dearly hope it doesn’t get there because my life, my business, my income, my prosperity depends as much on a bull market as everybody else who watches and appears as a guest on this channel. But that’s still not going to change where the markets are headed.

Q: After the summary of your situation, are you saying that what started a couple of months back is the start of a bear market?

A: Times change, themes change. As investors, we have to be cognizant of basic changes in strategy. The core problem with India is that market participants assume that a bull market is their birthright. There is no such thing.

I hear voices all the time saying that the local mutual funds should come out and support it or the FIIs should now express their faith in India. That is nobody’s business. Market support and putting money to work just to support a market is not a social responsibility.

So, let’s get that kind of spurious argument out of the way. Markets are about making money. If you do not see that market is going to make you money, you should sell rather than stick around hoping that markets will make you money. My sense is the bull markets started in 2003 with the global bull market. We were squarely in the middle of it. We did better than the globe, but we still were part of the global equities bull market. It has been our case that till environment remained; India would do well and in fact better. That happened till last November or December, which is when all our analysis or everything that we watched starting turning red. That is a time when we turned very cautious on the markets. Nothing that we see so far tells us that the bottoms have been breached or that you have reached a level of valuation that is comfortable. Everybody looks at Sensex P/Es and I have never found any use looking at that. You still have the growth.

The stocks that you want to buy are not cheap stocks. The stocks you don’t want to buy are cheap stocks. That is a conundrum. I mean IT is cheap, you don’t want to buy that. You want to buy the BHEL’s, L&Ts, but they are not cheap. So, what is the point in looking at the Sensex multiples and saying where the market is headed?

Our sense is FY09 numbers are still very optimistic by way of estimates. Those numbers will probably come in lower than what the markets expect. This is a classical situation that a big bull market is kind of grinding its way to at least some kind of an intermediate end. So, it will get to a situation of undervaluation kicking its cream. We will protest, we will fight it, we will resist it. But these things have to go where they have to, no matter what mutual funds do, or FIIs do. Something that has to reach a certain point will reach it irrespective.

After the P-Note ban is when the markets made its highs despite a net FII outflow. I have always said that flows don’t matter. Markets actually make the flows and flows don’t make markets. Now you are seeing that mutual funds are sitting on cash. Even if they put into work USD 4-5 billion, in a USD 1 trillion market, that is a drop in the ocean. Market will swallow it up, and if it has to go down, it will still go down.

My sense is it is too early to be brave in the market just now. Yes, you can say selectively there are pockets of value. But the fact is on a big macro basis, the trade is no longer equities. Not in India, not across the world. The trade lies elsewhere. Maybe you want to trade bonds, maybe that is a trade for the year, maybe selectively agri commodities is a trade for the year. But definitely not equities.

Source: Moneycontrol.com