Investors fear new economic downturn

Two years after the last recession ended, Wall Street is showing rising fear that the U.S. economy could be headed for a new downturn.

Stock prices plummeted in the U.S. and Europe on Tuesday, driving the Dow Jones industrial average to its lowest level since March and to its longest losing streak — eight straight sessions — since the October 2008 financial system meltdown.

Deepening investor pessimism about the world economy is posing a serious threat to already fragile business and consumer confidence at a time when policymakers appear out of fixes.

“The fears have gotten to the point where people are getting out of the way and saying, ‘Man, maybe this is a recession,’” said Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis.


The latest stock sell-off came even as the Senate followed the House in passing a bill to raise the federal debt ceiling, averting the possibility that the Treasury could default on its debts.

Despite some relief that Washington could forge an eleventh-hour compromise on the debt ceiling, analysts said the prospect of even modest federal budget cuts in an anemic economy was spooking markets.

“Investors are looking past the budget situation and realizing this is an austerity plan,” said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. “We have an economy that’s struggling to stay afloat and we don’t have the ammunition to keep prodding it forward.”

A cascade of selling knocked the Dow down 265.87 points, or 2.2%, to 11,866.62 on Tuesday, bringing its losses to 858 points since July 21. Investors are pouring money into safe-haven bets, pushing gold to an all-time high and U.S. Treasury bond rates to their lowest levels since last year.

In another sign of the faltering U.S. recovery, the government said Tuesday that consumer spending fell 0.2% in June from May, the first decline since September 2009. The report showed that Americans were reluctant or unable to boost spending despite a steep slide in gasoline prices in late spring.

On Monday, a survey of manufacturers nationwide in July showed that factory activity expanded at the slowest pace in two years. And late last week the government estimated that the economy grew at a paltry 1.3% annualized rate in the second quarter.

Yet many analysts, noting the stock market’s penchant for overreaction, caution against jumping to the conclusion that the economy is falling off a cliff.

In a potentially good sign for the job market, new claims for unemployment benefits fell last week to the lowest level since early April.

U.S. car and truck sales in July were sluggish, but that partly reflected a continuing shortage of some vehicles as Japan recovers from its devastating earthquake in March. And industry reports of retail store sales in July “suggest faster spending growth than in June,” economists at brokerage UBS said in a report.

Wall Street optimists have been betting that the global economy simply hit a “soft patch” in recent months, brought on in part by the surge in oil prices in winter and early spring. With oil prices sliding again to under $94 a barrel Tuesday, down 18% from the spring peak of nearly $114, that should provide more relief at the pump soon.

What’s more, the end of the debt ceiling drama in Washington at least removes that cloud of uncertainty over the markets. On Tuesday, two of the three major credit rating firms, Fitch Ratings and Moody’s Investors Service, said they would keep the U.S. government’s debt rating at the top-rung AAA level, for now.

Although the stock market has crumbled in recent days, major U.S. indexes still are up sharply from their lows of last summer. Analysts note that it isn’t unusual for stocks to periodically drop 10% to 15% in bull markets when bad news hits.

The Dow index now is down 7.4% from its multiyear high of 12,810 reached April 29.

The risk is that a sustained decline could create a vicious cycle, fueling pessimism about the economy that then feeds back into markets.

Some big investors say they are riding out this slide, encouraged by the generally strong earnings that blue-chip companies have reported for the second quarter.

“We’re sitting tight for the time being,” said Mark Foster, who oversees $500 million in client assets at money manager Kirr, Marbach & Co. in Columbus, Ind.

Many firms have sounded optimistic about their earnings prospects for the rest of the year, Foster said. “Even though the U.S. isn’t showing great growth, companies are seeing it in international markets,” he said.

The domestic economy also could get a boost from falling long-term interest rates. As investors have rushed into Treasury bonds in recent days, seeking relative safety for their money, they have pushed market rates down dramatically.

The rate, or yield, on the 10-year Treasury note plunged to 2.61%, down from 2.75% on Monday and the lowest since November. Because mortgage rates key off the Treasury note rate, home loans could quickly become cheaper for borrowers who can qualify. That could help the moribund housing market.

But without job growth the pool of potential home buyers may not expand much. The government will report Friday on July employment trends, and analysts expect that the economy created just 85,000 net new jobs last month.

Meanwhile, Europe’s government debt crisis is worsening again, posing a new threat to the global economy.

Just two weeks ago the European Union agreed on a new bailout for Greece. Now fear that Italy and Spain, two much larger economies, also may need bailouts has sparked heavy selling of European stocks in recent days. The Italian market has dived 11% in the last seven days and is down 25% since mid-February.

“More and more investors are realizing that there’s no quick fix” for debt-ridden economies, said Matt Zeman, a strategist at Kingsview Financial in Chicago.

That also is what could hobble policymakers, including the Federal Reserve, even if they had the desire to try more stimulus measures for the economy. Fed policymakers will meet Tuesday.

“It will be too early for the Fed to conclude they have to do something,” said David Resler, chief economist at Nomura Securities in New York.

Even so, he said, the central bank may have no choice but to indicate “a willingness to do something” if things worsen substantially.