Recession Fears Hit Home as World Markets Plummet and U.S. Economy Contracts

By , Money Morning •

By Jennifer Yousfi
Managing Editor
Money Morning

Fear of a global recession is quickly becoming reality as world markets have lost $10 trillion in value in the month of October and the U.S. economy almost certainly contracted in the third quarter.

“The growing reality is that this is not just a slowdown, but a true recession,” Joel Naroff, president and chief economist of Naroff Economic Advisors told Money Morning Friday. “Europe and Asia can no longer deny U.S. problems are also hitting there.”

Friday was the 79th anniversary of 1929’s “Black Thursday,” when U.S. stocks were decimated at the start of the Great Depression. And while U.S. markets weren’t quite as hard hit on that date in 2008 as they were in 1929, the overall global effect was chilling.

This October is on track to be the worst since the crash of 1987.

The MSCI World Index has been decimated as each of the 48 developed nations tracked by MSCI Inc. (MXB) have marked a decline so far this year, with 22 of those nations down more than 50%, Bloomberg News reported.

Emerging markets, the global superstars of growth in 2007, are also slowing. Of the “BRIC” nations of Brazil, Russia, India and China, Russia has been hit the hardest. Russia’s Micex Index is down more than 73% year-to-date. China’s stock market is down more than 60% from its peak.

All three major U.S. indices have racked up steep losses for the month of October and are deep in bear market territory for the year.

The month has seen unprecedented government intervention into the private markets, including coordinated interest rate cuts and widespread bank recapitalization measures, but global stock indices continue to fall. The U.S. Federal Reserve is slated to begin a two-day meeting tomorrow (Tuesday).

"The outlook for the market really depends upon what type of action the Fed may take," Doug Roberts, chief investment strategist for Channel Capital Research in Shrewsbury, New Jersey, told Reuters. "I wouldn't rule out the possibility of something on a coordinated basis globally as well."

Widening Swath of Recessions

Friday’s steep sell-off was sparked in part by the British Office for National Statistics’ announcement that, after a flat second quarter, U.K. gross domestic product (GDP) contracted 0.5% in the three months ended Sept. 30. It was a sharper decline than expected, as median economists’ estimates projected a 0.2% decline, according to Reuters.

Howard Archer, economist at Global Insight Inc., said the reading indicates that the United Kingdom is in a recession.

“The depth of the decline means that we are there to all intents and purposes. Indeed, there can be no doubt that further marked GDP contraction will occur in the fourth quarter as consumers retrench in the face of major headwinds and investment is pared back sharply,” Archer told The Financial Times.

Other European nations have already succumbed to recession, while still more are teetering on the brink of economic contraction. Germany, the EU’s largest economy, is expected to see a 0.2% contraction in gross domestic product (GDP) for the third quarter after a 0.5% contraction in the second quarter. And the nation of Iceland is dangerously close to bankruptcy.

In Asia, Japan – the world’s second largest economy – is also dangerously close to recession. Japan’s GDP contracted 2.4% in the three months ended June 30 after expanding 3.2% in the first quarter.

Worse, the United States could be next.

U.S. Economic Peril

U.S. GDP for the second quarter clocked in at a surprisingly strong 2.8%. But the advance estimate for third quarter U.S. GDP is slated for release this coming Thursday, and according to Naroff, the world markets could very well be in for another shock.

“U.S. GDP contracted significantly in the third quarter,” Naroff said. He predicts GDP may have fallen as much as 2.5% - 3.0%. “Such a sharp slowdown is not expected.” 

Global investors might not expect such a sharp decline, but a dire stream of economic indicators has been flooding in for months and they haven’t painted a pretty picture.

“We expect our number next week not to be a good one, and the next quarter could probably be tough as well,” White House Press Secretary Dana Perino said at a White House briefing on Thursday, referring to the upcoming GDP announcement, Bloomberg News reported.

“The president knows that we're in for a rough ride,” Perino said. 

According to Bloomberg data, median economist expectations predict a 0.5% contraction in U.S. GDP for the third quarter.

U.S. unemployment continues to rise and a slowdown in consumer spending, which is responsible for two-thirds of GDP, is bound to slowdown.

“I don't see how the consumer can do anything but retrench,” Robert McTeer, former president of the Fed Bank of Dallas, said in an Oct. 24 Bloomberg Television interview. “If they all do it at the same time, it will really tank the economy.”

Analysts from Citigroup Inc. (C) predict the United States could see an entire year of contraction before the economy gets back on track, shrinking throughout the first half of 2009.

“We are now expecting one of the sharpest recessions in the post-war period,” Citigroup's Geoffrey Dennis and Jason Press wrote in a report to clients on Oct. 21.

Dennis and Press also predicted that U.S. unemployment could reach as high as 8.5%.

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