Talk of slowdown causes recession in market confidence

NEW YORK -- Feeling glum? Unsure of the future? Putting plans on hold? Hoarding cash and buying gold?

Chances are your negative state of mind has a lot to do with the double-dip crowd's Weather Channel-like warnings of another catastrophic economic storm bearing down on the USA. The drumbeat of recession talk, which gathered steam Friday after the government reported that the economy created no jobs in August, has all but cemented a recession in the minds of investors — but not necessarily the type that is measured in negative GDP, ever longer lines at the unemployment office or shrinking output at factories. At least not yet.

Instead, the gloomy predictions about the economy, which is now operating at stall speed, is causing a different type of contraction: shrinking confidence.

"We are definitely in recession, but it is a confidence recession. Not an economic one," says Jeffrey Kleintop, chief market strategist at LPL Financial.

Still, renewed turbulence Tuesday in Europe and fresh fears that the eurozone's debt woes will worsen and hamper growth in the U.S. sent the Dow Jones industrial average tumbling 100.96 points, or 0.9%, to 11,139.30.

In theory, the economy is not in recession, which is defined as two consecutive quarters of negative GDP. The economy crawled along at a growth rate of 1% in the second quarter of 2011 and 0.4% in the first three months of the year. But Wall Street has increased the odds of a recession to around 40%. And the market's nearly 20% drop from its April high suggests investors are already pricing in a "mild recession," Deutsche Bank says.

This debilitating drop in optimism — if it persists — could act as a mental roadblock and rile markets. A confidence recession poses dangers to the economy, because when the masses think the future is bleak, not bright, the negative thinking manifests itself in all sorts of hunker-down behaviors that act as a drag on growth.

The fear: All the negativity puts a chilling effect on risk-taking and prompts investors, consumers and businesses to play defense.

The potential fallout: Austerity replaces spending. Hoarding cash trumps longer-term investing. Businesses spend less on future initiatives and hire fewer workers.

The risk: A negative feedback loop takes root that could cause worries about recession to turn into a self-fulfilling prophecy.

No good news

The historic market volatility the past five weeks is due to the growing perception that the economy is suffering from more than just a soft patch and is just one shock away from tipping into recession.

Still-visible scars from the 2008 financial crisis are adding to the uncertainty.

"We are in the middle of a mania of pessimism," says James Paulsen, chief investment strategist at Wells Capital Management. "We have a crisis-phobic investment culture. The nation is suffering from 'Armageddon hypochondria.'"

Daniel Robb, 41, of Washington, D.C., a self-described "natural optimist" who has always sought buying opportunities on market dips, now fits the profile of a pessimist hunkering down until economic clouds move out. He blames a lack of leadership from President Obama and his economic team, as well as Congress, for ratcheting up his anxiety level.