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Stock market begins to feed economic fear

Monday - 8/22/2011, 9:26am  ET

By BERNARD CONDON and CHRISTOPHER RUGABER
AP Business Writers

NEW YORK (AP) - The stock market is starting to feed economic fear, not just reflect it.

Stocks have fallen four weeks in a row. Some on Wall Street worry that the resulting blow to confidence, not to mention 401(k) statements, has set off a spiral of fear that could push prices even lower, cause people and businesses to pull back and tip the economy into a new recession.

"I'm nervous that fear will lead companies to stop hiring and people to stop spending," says Jim Paulsen, chief investment strategist of Wells Capital Management, famous for his usually bullish take on the markets.

A home sales report this past week showed that more sales than usual fell apart at the last minute, which suggests plunging stocks and dismal economic news gave buyers cold feet. At least 16 percent of deals were canceled ahead of closings last month, four times the rate in May.

Beth Ann Bovino, senior economist at Standard & Poor's, says that another big plunge in stocks could "push us closer to the brink."

The Standard & Poor's 500 stock index ended Friday at 1,123.53, down 5 percent for the week. The average is down 16 percent during the four-week losing streak. One reason for the drop is fear that another recession, if not certain, is more likely now.

The run of bad economic news started last month when the government said the economy grew much more weakly in the first half of this year than thought. Growth, at an annual rate of 0.8 percent, was the slowest since the Great Recession ended in June 2009.

The economic weakness has made investors more likely to sell stocks at the first hint that things are getting worse. And last week, they got signs aplenty.

A regional survey by the Federal Reserve said manufacturing had slowed in the mid-Atlantic states by the most in more than two years. Existing home sales fell in July for third time in four months. Another report showed that exports from Japan, the world's third-biggest economy, had slumped for the fifth straight month. Japan is still reeling from the effects of an earthquake and tsunami in March.

The housing market, which usually helps lead an economic recovery, keeps getting worse. The plunging stock market and scary economic news won't make it any better.

"What you're seeing with the economy, on the job front _ it's scaring a lot of people," says Brian Fine, a loan manager at Mortgage Master in Rockville, Md. He says the housing market will languish until buyers and sellers feel more secure about the economy.

"People are really motivated by larger economic trends. It's all about if you feel confident enough to buy a home right now," he says.

The news from Europe got worse, too. Its economy has slowed considerably _ even in Germany, which has been its greatest source of strength. Fear spread that European banks, already ailing because they hold bonds of countries that are struggling with debt, were having trouble getting short-term loans to pay for day-to-day activities.

Some Wall Street analysts say reports of trouble were exaggerated, but that didn't seem to matter. For investors, the prospect of banks scrambling for cash dredged up bad memories of the global credit freeze that hit in the fall of 2008 _ and they sold stocks.

"A negative feedback loop ... appears to be in the making," two economists at Morgan Stanley wrote Thursday in a widely cited report that itself seemed to beget more fear and selling. It warned that the U.S. was "dangerously close" to recession.

Stock investors aren't the only ones worried. Martin Fridson, global chief credit strategist at BNP Paribas Investment Partners, notes that investors in bonds issued by the riskiest U.S. companies are dumping them, too. These investors fear that in a recession companies might not be able to pay interest on these so-called junk bonds.

The selling has forced up the average interest rate on the bonds to 8.3 percent. If investors had faith in the economy, the rate would be 4.6 percent, Fridson says.

"I'm nervous," says Fridson, who has followed the junk bond market since 1984. "I think there's a very material risk of falling into recession."

Investors are responding to the risk by putting their money where they feel safe. Demand for the 10-year U.S. Treasury note was so high last week that the yield dipped below 2 percent for the first time in half a century. And the price of gold has set one record after another. It topped $1,800 an ounce last week.

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