Indian equity prices have more than doubled in the 12 months after the main indices hit a bottom on 9 March 2009.

Back then, optimism was rare. Western banks were still wobbly, trade was collapsing and output was shrinking. Most people were quick to dismiss the rally as nothing more than a dead cat bounce. “The global markets have staged several bear market rallies since the beginning of 2008, and this one seems to be another of the sort," we had wisely commented in these columns on 16 March 2009. Most other commentators and analysts made the same mistake.

Illustration: Jayachandran / Mint

Equity investors were among the early few who saw that the world economy had a chance to recover, though slowly and painfully. The past 12 months are further proof that financial markets tend to change direction before the underlying economies do. That’s a useful adage to remember in this silly season when financial speculators are being attacked for the woes of Greece and the world beyond. One European leader even said recently that governments have “instruments of torture in the basement" and would be only too happy to use them against traders who bet against governments.

It’s not all over as yet. The magnificent rally since March 2009 could run out of steam or, even worse, be finished off in a new bout of selling. The nature of risks has changed. The big fear in the last quarter of 2008 was a financial meltdown after the collapse of investment bank Lehman Brothers. The worries changed in the first quarter of 2009 as economies slipped into recession and unemployment climbed. The fiscal stimulus packages have helped stabilize global output but the risks have now shifted to the balance sheets of governments. “A few sovereign defaults could ignite another round of fear and risk aversion," we had also written.

Meanwhile, slack monetary policies have unleashed a flood of liquidity that has raised many boats—equities, bonds, metals, gold and oil. Inflation has started climbing. Oil presents a challenge that is not fully appreciated. Higher oil prices could pull down growth in many countries and send price levels further up— stagflation, in other words.

India and China have done far better than most other major economies, with V-shaped recoveries and early moves to exit loose fiscal and monetary policies. The markets will be watching all these economic trends closely, especially as Western governments and central banks try to withdraw stimulus programmes from weak economies.

A long plateau may lie ahead.

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