After two days of near-euphoria on the stock markets, reality kicked in today and the City remembered that a recession — or worse — remains likely.

Investors sold strongly as they sought to lock in gains on this week's rally or cut losses from earlier misadventures.

The recent bounce in global markets looked shortlived — the FTSE 100 index fell 239.85 to 4154.36 — as the £90 billion wiped on to the stock market on Monday was quickly wiped off.

Lloyds TSB and Royal Bank of Scotland were two of the only three stocks in the Footsie to rise as investors bet that they may be able to take a Government bailout and still pay dividends.

Lloyds TSB charged up 10.3p to 161.6p on hopes that it could persuade the Treasury to alter the terms of its deal with HBOS. At the moment, if it takes capital injection from the Government, it must agree to pay no equity dividends until it has repaid the Treasury, which could take until 2012. Royal Bank of Scotland rose 2p to 67p.

Bad news from Wall Street increased London's woes. Fresh economic data strongly suggested the US is either in a recession or moving toward one.
Retail sales plunged in September by 1.2% — almost double the 0.7% drop analysts had expected. Consumer spending accounts for more than two-thirds of US economic activity.

Matt Buckland, a dealer at CMC Markets, said: “After a bumper start to the week, the inevitable reversal for equity markets does seem to be under way. We're seeing some profit-taking and a reassessment of positions after the upswing, although there is an element of concern as to the longer-term economic outlook creeping in here.”

London-based analyst Capital Economics is advising clients not to race into shares, saying the history of recessions suggests the market only really recovers a few months before the economy turns the corner.

It added: “Equities could remain under pressure during the first half of next year even if the bank recapitalisation helps to restore some confidence.”

The biggest FTSE 100 losers were mining and insurance stocks.

Andrew Turnbull at ODL Securities said: “After the colossal gains at the start of this week, it would seem the hangover has kicked in and investors have sobered to the reality recession is here.

“We are continuing to see faltering confidence in a number of different areas of the markets and, after having seen so much cash being pumped into the troubled banking sector, we really should be seeing a stronger rally in worldwide markets.”