US stocks sank to their lowest since October 2006 on fears that a contraction in US manufacturing may tip the economy into recession.
Equities slumped after Federal Reserve chairman Ben Bernanke's endorsement of the need for a fiscal stimulus package underscored investors' concerns that the US economy is facing a sharp slowdown.
Bond insurers plummeted after Moody's put Ambac Financial on review for possible downgrade, adding to worries about this credit market linchpin. Meanwhile, Merrill Lynch triggered a slide in banking stocks after the brokerage slumped to a $9.8bn quarterly loss.
The S&P 500 fell 2.9 per cent to 1,333.25, hitting its lowest level since the aftermath of Hurricane Katrina. The Dow Jones Industrial Average gave up 307 points, to close 2.5 per cent lower at 12,159.21.
The Nasdaq Composite fell 2 per cent to 2,346.90 leaving the tech index 17.9 per cent below its October peak, on the verge of a bear market. Small cap stocks have already passed that marker, with the Russell 2000 now 20.5 per cent from its peak last July, after posting decline of 2.8 per cent to 680.57 on Thursday.
The CBOE Vix index - Wall Street's so-called fear barometer - shot up 16.6 per cent to 28.42, its highest since the end of November.
Stocks went into a spin after the Philadelphia Federal Reserve's regional manufacturing index contracted sharply. The report added to concerns that US manufacturers are experiencing a marked slowdown, coming soon after the Institute for Supply Management's manufacturing index also weakened decisively.
"The manufacturing collapse in the Philly index today was a bad number," Jim Paulsen, chief investment strategist at Wells Capital Management, said. "Pretty much everything about the survey was bad."
Echoing these problems Harley Davidson shed 6.8 per cent to $36.95 after Citigroup told investors to sell the motorcycle manufacturer because it expects US retail sales to decline 10-12 per cent in the fourth-quarter.
Traders were not reassured by Ben Bernanke's Congressional testimony, where he pledged his support for a quickly implemented fiscal stimulus package but cautioned against widening the US budget deficit. His comments came as the White House confirmed that President Bush believes some kind of fiscal boost is necessary but did not provide details.
The real-estate sector showed no sign of improving as housing starts fell 14 per cent to 1.006m units last month, the lowest since May 1991. Meanwhile building permits fell 8.1 per cent in December, capping their worst annual decline since 1974.
"Housing starts and building permits collapsed," said TJ Marta, fixed-income strategist at RBC Capital Markets. "These figures point to a continued contraction in residential investment that will act as a drag on gross domestic product throughout 2008."
Better news on the employment front was quickly forgotten on Thursday amid the gloomy outlook for the US economy. Initial jobless claims fell 21,000 to 301,000, their lowest since September.
Corporate news was led by Merrill Lynch, which wrote down $16.7bn of credit assets and fell to a $9.8bn fourth-quarter loss, much worse than analysts had predicted.
Merrill's shares dropped 10.2 per cent to $49.45. The S&P investment banking index slumped 5.4 per cent.
Monoline insurers plunged after Moody's Investors Service put Ambac Financial on watch for possible downgrade.
Ambac's shares slumped 51.9 per cent to $6.24 while MBIA (NYSE:MBI), a rival insurer, fell 31.2 per cent to $9.22
Downgrades of bond insurers could have repercussions for the credit markets which depend on their triple-A ratings to guarantee bonds of less credit-worthy companies.
Commodity producers continued in free-fall after UBS initiated coverage of Monsanto (NYSE:MON) with a neutral rating and said the agribusiness could miss expectations for the second quarter. The shares fell 11.6 per cent to $99.61.
Fertilizer producers were also heavily sold after an analyst at Morgan Stanley raised concerns about potash inventories. Mosaic, lost 11.7 per cent to $81 and Potash (NYSE:POT) fell 10.7 per cent to $120.24.
Thursday's falls leave the S&P down 9.2 per cent for the 2008 while the Dow has given up 8.3 per cent and the Nasdaq 11.5 per cent. The speed of these falls has surprised some analysts who believe the Fed may yet step in to cut interest rates, ahead of its late January meeting.
"I do think people - even bears - are getting a little hesitant here by the speed in which this has come down, and therefore how aggressive the Fed might be," Mr Paulsen said.
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