World markets bleed

7:09 PM ET | Last Updated: Aug 4, 2011 7:13 PM ET

Investors are losing faith in the global economy and the policymakers in charge of keeping it afloat, putting the two and a half-year bull market in serious jeopardy.

Stock markets around the world plummeted their most since the financial crisis on Thursday, as escalating U.S. recession fears and Europe’s ballooning sovereign debt crisis were further exacerbated by an emergency intervention of the Japanese yen.

“It’s getting more and more difficult to see the glass half full,” says Serge Pepin, head of investments at BMO Investments Inc. “I’ve always been sort of an optimist if anything, but it is definitely not a rosy picture.”

The S&P/TSX composite index, Canada’s key equity benchmark, suffered its biggest drop since June 2009, by falling 435.90 points or 3.4% to close at 12,380.13. It was the eighth time in the past nine sessions that the market has tumbled.South of the border, the Dow Jones Industrial Average dropped 512.76 points or 4.31% to 11,383.68. It was the Dow’s worst point drop since December 2008.  With each market now down 13% and 11% respectively since their most recent peaks in April, stocks have dropped well below the 10% pullback that marks an official correction.

Mr. Pepin said investors are starting to question whether the bull run that began on March 9, 2009 has finally come to an end.

“We are now more than 20% off the market’s all-time high in 2007, so by some people’s definition, we’re already in a new bear market,” he said. “If we can get a clear signal from the U.S. economy that things are moving to the positive, that’s when people will get some solace. At this point we just aren’t seeing that.”

In this type of environment, it makes sense that investors are selling some of their riskier assets including cyclical stocks and commodities, in favour of so-called safe haven investments, such as bonds, defensive equities like consumer staples and healthcare, and gold, which briefly hit another record high at US$1,684.90 an ounce on Thursday.

That said, Mr. Pepin thinks it’s premature to compare the market’s recent malaise with the extreme meltdown that occurred in 2008 at the height of the financial crisis.

“I think this is strictly sentiment and we are getting close to a bottom, ” he said. “I don’t believe we are headed for recession and corporate earnings are still very strong. That has to matter for investors.”

Just how much futher markets will fall could hinge on Friday’s crucial U.S. jobs report for July. If figures are better than estimates calling for an increase of 85,000 in non-farm payrolls and an unchanged unemployment rate at 9.2%, then a relief rally could take place. If the opposite transpires, the sell-off will likely only get worse, as the risk of a U.S. recession moves closer to reality.

“The economy is only one shock away from falling into recession,” said Michelle Meyer, an economist at Bank of America Merrill Lynch, in a note to clients Thursday.

Ms. Meyer believes there is now a 35% chance of a U.S. recession in the next year, about double what her odds were this spring.

With this week’s new debt deal in place, there is no appetite in Washington to provide more fiscal stimulus in aid of the slumping recovery, she said. At the same time, the Federal Reserve, which has left interest rates at near zero for nearly three years, may not have enough ammunition left to prevent another contraction.

On the one hand, investors are in a state of confusion and alarm, not knowing if the world’s problems can be resolved, said Andrew Pyle, a financial advisor at ScotiaMcLeod. On the other hand, panic is often the mother of all innovation.

“The [market slide] is creating the same pro-growth elements as we’ve seen before, such as lower energy prices and interest rates,” he said.  “This doesn’t mean we jump and start loading up on equities, but as Warren Buffett says the best time to buy is when there’s blood in the streets.”

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