Global stock markets are poised at a puzzling fork in the road to recovery. Wall Street slumped 240 points on Friday, ending a seven-month streak of monthly gains. This fall is despite the Thursday release by the US government that the world’s largest economy had come out of a year-long recession in the third quarter of the calendar year. The most widely followed volatility index had its biggest one-day percentage gain in a year, an indication of renewed fear among investors.

Illustration: Jayachandran / Mint

It is foolish to try to predict what can happen in the future. Equity prices across the world staged a spectacular rally since March—a rally that was confidently dismissed as a dead cat bounce by most analysts and commentators, including this newspaper.

The moves from March were not unjustified. The world economy did pull back from the brink and the global financial system did not collapse, in large part to the unprecedented interventions by governments and central banks. The fact that interest rates hit rock bottom in the rich countries also helped make equities more attractive than bonds, even as they saw the growth of the dollar carry trade.

There are now concerns on both fronts: economic fundamentals and liquidity. The third-quarter economic growth in the US is impressive, but too much of it has come from one-time factors (such as the subsidies that were dished out, till end-August, to American consumers who traded their old cars for new) and from government spending. Unemployment continues to rise and private sector consumption and investment demand is very weak. It’s much the same case in most other rich countries.

India and China have their own set of problems, even though the International Monetary Fund said last week that these two Asian countries are leading the world economy out of recession. India has to start tackling a huge fiscal deficit and has been hit by a poor monsoon. China seems to be hurtling towards another credit-induced bubble.

But the biggest fear is the inevitable withdrawal of liquidity as economies have pulled back from the brink, and there are renewed fears of inflation a few quarters down the line. Investors seem to be reacting to all these factors.

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