First of all, if we look at global markets, the big issue remains the US economy. Will the economy in the US go into a recession? Can the US consumer once again dodge a bullet and overcome the housing slowdown?

How will the impact of the sub-prime meltdown affect financials (nearly 30 per cent of US earnings) and the broader economy? Can the global economy truly de-link from a US slowdown as markets and commodity prices seem to indicate?

Can the huge improvement in US corporate profitability be sustained? Are we headed towards stagflation in the US as productivity slows in sync with a slowing economy? Will the Fed really be in a position to cut rates by the middle of this year and bail out markets, as many people implicitly assume?

Many questions, to which the answers are not intuitively obvious. While the markets have broken out to the upside, I still feel that the environment will not be easy as people think. Investors seem to be willing to ignore risk and implicitly assume that things will eventually work out just because they have in the past few years. The bears have been harping about these issues for years now, but always been wrong.

There seems to be a lot of complacency among investors and an unwillingness to look at negative data points.

Even in China, the environment is clearly worsening. You have a situation wherein the government clearly wants to slow down the economy and curb investment growth. While they may not succeed in the short term, the direction of government policy and intention is clear. This cannot be good for financial markets, and, as we discovered in February, China does matter.

As for India, the environment has also clearly worsened. The big issue is the extent of the oncoming slowdown, for a slowdown itself is now inevitable. Will the economy drop from 9.2 per cent GDP growth to 8 per cent or will we drop still further?

We as a country have now got used to GDP growth in the range of 8-9 per cent, even 6 per cent, the long-term trend till 2003 will now seem like a recession. If the RBI has overshot and we do drop below 8 per cent economic growth, then the markets will have a problem as corporate performance will clearly disappoint. We will very quickly build excess capacity across sectors in such a scenario.

The other concern I think investors have is the uncertainty around government policy. The actions taken by various ministries designed to control and direct industry-level prices and profitability do not inspire confidence. Investors are now wondering which industry is next, and what the government will do this time. What prevents the government from deciding that some other industry is making too much money and going after it?

A certain predictability towards government economic policy making has been lost. If someone had told you a month ago that the GoI will discriminate against Indian cement manufacturers, in favour of cement imported from Pakistan, he/she would have been laughed me out of the room, but that is exactly what is happening.

India is ultimately a growth market, and the value of a growth company depends on its future expected profitability. The higher the predictability and absolute level of future profitability, the higher will be valuations, to the extent you cannot predict future profitability or it gets clouded because of extraneous government actions, the value of a company or market will reduce.

Till three months ago, the cement industry had probably the best visibility among sectors in terms of demand/supply balance and expected profitability, but all that changed with a stroke of the government's pen. Actions such as this will bring into question why investors should be willing to give a high valuation to any company or sector in whose economics the government can interfere.

Investors are currently willing to ignore these actions on the part of the government as being driven by short-term political considerations; if, however, this continues or broadens, it may cause serious damage to the market and multiples.

Even the actions of the RBI appear to be more aggressive than required. They seem to feel they have fallen behind the curve and are now scrambling to get in front of inflation expectations. Everyone is convinced that over the next couple of months, the inflation numbers will come down on their own through crop arrivals and the base effect; yet the RBI deems it fit to tighten the monetary environment in between monetary policy meetings.

What does the RBI see that we investors do not? What is the endgame of the RBI? If we have a poor monsoon in June-September, does that mean that the RBI will keep tightening monetary policy to counteract the price impact of poor harvests independent of economic growth?

All this uncertainty is negative for markets and has to have an impact eventually. The one thing investors hate above all else is uncertainty; it is corrosive for markets and especially valuation multiples. The inevitable consequence of an uncertain economic or stock market outlook is a market de-rating, as investors reduce risk appetite and market commitments.

Rising interest rates are another factor that will serve to pull down valuation multiples, as the required rates of return on equity investments rise.

The market multiples in India have risen from about 10 times one year forward in 2003 to something in the region of 16 times currently. This PE expansion has been a big driver of the market rise along with strong earnings.

This PE expansion story is now more or less done, and we should expect if anything some de-rating of multiples from here. The market has only the earnings growth plank left, and one should keep a hawk eye on earnings trends; any damage here and the market is in trouble.