Growing recession fears clobber stocks

NEW YORK -- Wall Street is back in nose-dive mode, with investors who fear another recession selling like it's 2008 all over again.

Investors are aggressively dumping stocks, commodities and other financial assets whose fortunes are tied to the health of the world's increasingly interconnected global economy. The latest flight from any investment deemed risky is being driven by growing worries that central banks, lawmakers and policymakers lack the needed ammunition, tools, ideas and will to avert a global economic downturn.

"The fear is we could be on the cusp of another global slowdown," says Rod Smyth, chief investment strategist at RiverFront Investment Group. "Europe is definitely going into recession. The U.S. is slowing, but clearly any growth momentum has stopped. And policymakers are not giving us any belief in that they know what to do."

The rising angst is evident in the plunging Dow Jones industrial average, which fell 391 points, or 3.5%, to 10,734 on Thursday. The Dow's two-day drop of 675 points was its worse since November 2008. Just days after the Dow jumped nearly 5% last week amid a confidence-boosting five-session win streak, gloom is again descending as hopes for an economic jump-start and market-friendly resolution to Europe's sovereign debt woes grow dimmer.

For now, investors are seeking safety and shelter mainly in cash and U.S. government bonds. That is where investors are parking the bulk of the money they raise from selling stocks and commodities, such as oil, copper and steel. The yield on the 10-year note tumbled to a record low of 1.73% Thursday as its price soared.

In another sign of just how nervous investors are, metals such as gold and silver, which had been considered havens in prior stock sell-offs and have been big winners this year, also suffered sharp declines. An ounce of gold fell $66.30 to $1,739.20, and silver fell 10%.

'Significant downside risks'

Investor pessimism seems to have accelerated after the Federal Reserve acknowledged Wednesday that there are "significant downside risks" to the economic outlook. Investors were also underwhelmed by the Fed's latest bond-buying plan, called Operation Twist, to help jump-start the economy, arguing that it is not likely to have the desired effect of boosting animal spirits among consumers, home buyers and investors.

Data released Thursday showing a slowdown in manufacturing activity in the eurozone and China added to the rising double-dip fears.

David Kelly, chief market strategist at JPMorgan Funds, says the big problem with the Fed's downbeat statement is that it convinced investors of two things that can be construed only as negatives. "The first is we still have an economic problem that needs to be dealt with, and the second is the Fed doesn't have the capability to deal with it," Kelly says.

Fed Chairman Ben Bernanke has stated that easy monetary policy, in the form of low interest rates, is losing its effectiveness in treating what ails the economy: namely a lethal combination of consumers' high debt loads and low confidence made worse by a weak job market.

The sharp jump in fear among investors, an ongoing theme that has accompanied some of the most violent price swings in stock market history in recent weeks, is also part of the problem, says Donald Luskin, chief investment officer at TrendMacro.

He says the level of fear has been rising and has been a big negative for the U.S. economy, which is built on the confidence of consumers, whose spending accounts for nearly two-thirds of the nation's economic activity.

"Fear has been eating away at the foundation of the economy for a while, like the way termites eat away at the walls of a home, one bite at a time — and then one bite and the whole wall comes down," he says.

But Luskin says fear of a severe recession may be misguided, unless worst-case fears materialize.

"Stocks are so cheap — unless you want to argue that an asteroid will hit Earth or there will be a Lehman-style systemic banking crisis, this is an either-or trade," he says. "Either those bad things happen or they don't, and this is a good time to buy."

The bankruptcy filing of Wall Street titan Lehman Bros. in September 2008 caused global credit markets to freeze up, triggering the worst phase of the financial crisis.

Lack of Fed power?

While sagging confidence is part of the problem, it's not the only problem plaguing markets. One of the biggest problems is the growing concern that the nation's central bank has little power left to get the economy back on track. Investors don't think the Fed's latest unconventional moves will be any more successful than its earlier bond-buying programs, dubbed QE1 and QE2 (for quantitative easing), which did little to spur long-term job creation or economic growth.

The latest example of that is the market's no-confidence vote since the Fed rolled out Operation Twist Wednesday afternoon. The goal of selling shorter-term bonds in the Fed's portfolio to buy longer-term bonds through June 2012 was meant to push long-term rates lower to entice investors to take on more risk, as well as provide a lift to the depressed housing market.

But Wall Street says the $400 billion is not enough to move the economic needle, as the Fed is not injecting new money into the system, but simply shifting existing capital. Nor do investors think that trimming an additional quarter of a percentage point off 30-year fixed-rate mortgages, already at historic lows of around 4%, will equate to more mortgage applications, given that bank lending standards remain tight and many Americans owe more on their homes than they are worth.

Washington gridlock

Many investors are also losing confidence in politicians. Investors are still upset over the political brinkmanship that resulted in the USA's triple-A credit rating being downgraded and Thursday's tumult over the deficit that could end up in another government shutdown.

Says Ed Yardeni, economist at Yardeni Research, "It is becoming obvious that policy has become the problem rather than the solution to the economic problems. That's radically different than the past, when fiscal and monetary policy came to the rescue in the nick of time."