Updated at 4:10 pm, August 4, 2011
Fear gripped investors Thursday, sending stocks on a dizzying drop that accelerated throughout the day and wiped out all gains the market had made this year. All three major indexes tumbled more than 4 percent in a selloff that gained momentum throughout the day, fueled by growing concerns that the U.S. and global economies are sliding back into recession.
The Dow Jones Industrial Average plunged 512.61 points, or 4.3 percent, to close at 11,383.83. The losses left the index more than 10 percent below its May peak, officially marking a market correction.
The Standard & Poor’s 500-stock index tumbled 60.25 points, or 4.78 percent, to 1200.09. The S&P 500 is on pace for its biggest weekly drop in more than a year. The Nasdaq suffered even worse losses, dropping 136.68 points, or 5.08 percent, to 2556.39.
The Chicago Board Options Exchange Market Volatility Index, a measure of market fear better known as the VIX, shot up 35 percent. The blizzard of bad economic data that has troubled investors in recent weeks—the European crisis, dismal GDP numbers, weak manufacturing data, and low consumer confidence readings—has prompted a two-week selloff that, even before Thursday’s plunge, had erased more than $1 trillion in market value worldwide, according to Bloomberg News.
A small gain by the Dow Jones Industrial Average on Wednesday broke an eight-session losing streak. The last time the Dow posted nine straight losing sessions was 1978, when Jimmy Carter was president.
The prolonged slide might not have been as bad if lawmakers had cut short the debt-ceiling soap opera, now on hiatus until Congress returns next month, or if they had struck a bargain that addressed entitlement reform and tax reform. “But as it was, the deal was late and it was bad,” says Dr. David Kelly, chief market strategist for J.P. Morgan Funds. And investors who were hoping for a relief rally once a debt-ceiling deal was done have instead been greeted by fresh fears about a deepening debt crisis in Europe and another recession at home.
At least Washington and Wall Street managed to dispel the old saw that “gridlock is good” for the markets—a saying that isn’t backed up by historical data anyway, according to Standard & Poor’s Chief Investment Strategist Sam Stovall. Since 1900, Stovall wrote in a research note Wednesday, the average gain of the S&P 500 index in years during which Congress was split was less than half the gains made when the president and Congress are all from the same party.
The good news is that the stock market is notoriously poor at predicting recessions. It may be true that, as Stovall notes, every recession since 1948 has been preceded by a market decline of 14 percent or more. But the market often gets jittery even if recession isn’t on the horizon. Nobel Prize winning economist Paul Samuelson joked decades ago that “Wall Street indexes predicted nine out of the last five recessions,” and the numbers now may even be worse. Since World War II, Stovall says, there have been 83 pullbacks of 5 percent or more, but only 12 recessions.
The bad news is, of course, that investors still have plenty of reasons to speculate about economic contraction and the need for a third round of quantitative easing by the Federal Reserve. The Commerce Department reported Tuesday that consumer spending dropped in June for the first time since September 2009. The day before, the Institute of Supply Management said that manufacturing activity in July fell to its lowest level in two years. And on Friday, the government announced that GDP growth in the first half of the year was the slowest since the end of the recession in June 2009.
“Everyone realizes the economy is now on life support again,” says Stovall. “The soft patch has become even softer, and now the question is, will it turn into quicksand?”
As unnerved investors try to figure out the answer, they’ll be focusing next on the jobs data due out Friday morning.
More on the markets from The Fiscal Times:
10 Reasons Why There Won’t Be a Double-Dip Recession
Italy, Spain Debt Woes Rattle European Markets
Stocks Now Down for the Year