The Wall Street Journal-20080122-Credit Scare Spreads in U-S-- Abroad- Fears of a Recession Spark a Global Selloff- New Pressure on the Fed

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Credit Scare Spreads in U.S., Abroad; Fears of a Recession Spark a Global Selloff; New Pressure on the Fed

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A world-wide stock selloff suggested that recession fears are spreading beyond the U.S., and that the downturn in U.S. markets is dragging down share prices abroad.

While U.S. markets were closed yesterday for the Martin Luther King Jr. holiday, major indexes fell 7.2% in Germany, 7.4% in India and 5.5% in Britain.

That follows what has been a bad run for the Dow Jones Industrial Average, which on Friday finished at 12099.30, 15% off its record close of 14164.53 in October. The Dow is now uncomfortably near the 20% decline analysts commonly consider the mark of a bear market. Futures on the blue-chip average fell 4.3% yesterday in London trading.

American investors have shifted billions of dollars abroad in hopes that booming economies in Asia and Latin America would shake off economic woes in the U.S. and keep the world out of recession. But the drop in foreign markets is stoking worries that no stock market will be spared. This morning in Asia, major markets opened broadly lower.

The unraveling markets are boosting the pressure on Federal Reserve Chairman Ben Bernanke to slash interest rates to counter the threat of recession in the U.S. Fed policy makers meet next week, and it appears almost certain they will cut the central bank's short-term rate target, now at 4.25%, by at least a half percentage point. Officials will likely give close consideration to a three-quarters-point cut.

A cut before then isn't considered likely, but can't be ruled out if markets suffer badly. A rate cut just a week ahead of the Fed's meeting would deliver only a modest additional boost to the economy and could risk looking panicked.

For many months, flows of U.S. investment money to mutual funds investing abroad have dwarfed flows to U.S. stock funds. In November, the latest month for which figures are available, funds investing overseas took in a net $4.46 billion, while funds investing in the U.S. saw an outflow of $15.34 billion, according to the Investment Company Institute, a mutual-fund trade group.

That trend is now reversing. U.S. and European investors, seeking to preserve their gains, are repatriating money they invested in the developing world, helping drive those markets lower, analysts say. Andrew Freris, chief Asian economist at BNP Paribas, said much of yesterday's 5.5% plunge in Hong Kong-listed stocks probably was triggered by funds based in the U.S. and Europe retreating from what is one of Asia's deepest and most liquid markets.

Turmoil in overseas markets potentially tarnishes one bright spot for the U.S. economy: its relatively strong exports. But Fed officials seem likely to conclude this turmoil overstates the actual risks those countries' economies face, leaving the Fed unlikely to alter its own forecast materially. Fed officials' greater concern remains the domestic economy and the threat of a self-perpetuating cycle of tighter lending, reduced spending and employment, lower home prices and increased loan defaults.

Skeptics have warned for months that developing-country stocks looked like a bubble waiting to burst. When Russell Indexes searched its global stock database for last year's best-performing shares in dollar terms, 48 of the top 100 stocks were from India, China, Brazil or Russia -- with 41 from India alone. Only six U.S.-based stocks made the list.

The benchmark indexes of India, Brazil, Turkey and Indonesia all climbed more than 40% last year. In China, a speculative frenzy helped push the Shanghai Composite Index 97% in 2007, even though the market is largely closed to foreign investors.

Many analysts believe the 30-stock Dow average is overdue for at least a temporary rebound, but so far there has been little sign of strength. U.S. stocks remain under serious pressure as once-bullish investors sell shares and shift money to cash, Treasury bonds and gold, seeking safety. Futures on U.S. stock benchmarks such as the Standard & Poor's 500-stock index and on the largest stocks in the Nasdaq Composite Index fell heavily in London yesterday.

"It does feel like there is panic out there, and there is little sense that it is bottoming out," said Lucy MacDonald, chief investment officer of global equities at RCM Ltd. in London. Ms. MacDonald, like many market participants, believes that the declines probably will continue through at least the end of this week, and that U.S. and European interest-rate cuts will be needed to pick markets up.

But foreign markets and futures trading historically have been unreliable predictors of U.S. stock action. Foreign markets typically react to developments in the U.S., rather than the other way around. In the year through October 2007, Brazilian stocks moved in the same direction as the S&P 500 more than 90% of the time, according to data from Citigroup. For Indian stocks, it was 70%.

Today's U.S. trading is likely to be influenced by a new batch of profit and economic reports. Ambac Financial Group Inc., Apple Computer Inc., Bank of America Corp., DuPont Co., Johnson & Johnson and Wachovia Corp. all are scheduled to post quarterly results today. If U.S. stocks rebound, foreign markets could well follow.

Strategists at Morgan Stanley told clients yesterday, however, to stay in cash. "We expect flat but volatile markets just as in the 1989-92 period -- a real whipsaw environment for the market," the Morgan Stanley report said.

Stock indexes in Britain, Germany and France suffered their heaviest percentage declines since Sept. 11, 2001, and in Hong Kong, the largest since Sept. 12, 2001. Indexes yesterday fell 3.9% in Japan, 5.1% in China and 6.6% in Brazil. Hong Kong-listed shares in Chinese companies fell more than 7%.

The pan-European Dow Jones Stoxx 600 index, which has fallen for six consecutive weeks, dropped an additional 5.7% to 308.77.

The dollar, in decline for years, rebounded 1.2% against the euro yesterday amid growing concerns that the European Central Bank would be forced to cut interest rates to support local economies. The dollar fell against the yen.

Fears that emerging markets might not be strong enough to keep the world out of recession knocked down a variety of industrial commodities tied to global growth. Copper was trading around 5% lower on the London Metal Exchange, while oil fell $1.97 a barrel to $88.60 in late-day electronic trading.

The dollar's strength in Europe supported it against gold, and gold, which has been pulling back as investors cashed in winnings after it surpassed $900 a troy ounce early this month, fell $8.30 to $872.50 in late-day electronic trading, the lowest in about two weeks.

Mining shares also fell. Vedanta Resources PLC dropped 12.1% and Rio Tinto PLC shed 10%.

Leading European financial companies were among the day's big losers, amid fears that they haven't finished taking write-offs. France's Societe Generale fell 7.8%, on top of a decline of almost 8% Friday; BNP Paribas was down 8.5%. WestLB of Germany added to concerns by saying it would have a loss of about $1.5 billion this year and take a write-off of similar size.

The head of France's central bank, Christian Noyer, said that French banks "clearly, like all banks in the world still [are] in the process of marking down assets."

Fears spread that bond-insurance companies could suffer further credit downgrades, hurting banks' ability to collect on battered securities. Bond insurers insure about $2.4 trillion of debt, including $100 billion of collateralized debt obligations linked to subprime loans, and further downgrades and the forced sales of bonds that would follow are a serious risk to credit markets, said UniCredit strategist Jochen Felsenheimer.

The Markit iTraxx Europe index, a widely followed benchmark that measures the cost of protecting bonds against default, rose to a record yesterday.

Some sectors that had been refuges for investors suffered in the selloff, including high-dividend stocks. "Some of the defensive stocks, such as utilities, are starting to crack now," as people lock in recent profits, said Bruno Berry, a fund manager at Morley Fund Management in London. "It is difficult to find a safe haven."

Among the rare gainers were government bonds, as investors fled to them for shelter.

Once sought-after markets in developing countries were among yesterday's hardest hit. Analysts said those markets could extend their losses if investors who poured money into Latin America, Asia and Central Europe in recent years grow increasingly averse to betting on the historically volatile regions.

Brazil has been an investor favorite because of its soaring sales to China. Investors betting on the export boom helped push Brazilian stocks up more than sixfold since 2002. The exports could slow if China's economic expansion cools in a global slowdown.

In Mexico, which gets nearly a quarter of its gross domestic product from exports to the U.S. and has the greatest exposure to a U.S. recession, stocks already are down more than 20% from their October high.

Some investors think Latin America's economies will weather the global shake-out better than in the past, when the region was plagued by financial crises and debt defaults. Countries such as Brazil, Mexico and Chile have boosted currency reserves, reduced their foreign-debt burdens and tamed inflation in recent years, improving their economic vigor.

Investors abroad shrugged off President Bush's economic stimulus package announced Friday and focused instead on their own failure to see the trouble brewing. "Global negative cues were ignored for quite some time, and now it caught up," said Ketan Karani, vice president for research at Kotak Securities in Mumbai, India.

Compounding the downward pressure in India was the launch of new initial public offerings. Many investors cashed out of stocks in the major market indexes to divert funds to those offerings, particularly that of Reliance Power Ltd., which allocated $3 billion in shares to investors last week in India's largest-ever IPO.

Elaine Chu, an analyst with Citi Investment Research in Hong Kong, noted in a report to investors yesterday that institutional funds were still flowing out of Asia and that these outflows "have not peaked," despite five consecutive weeks of net redemptions from offshore Asian funds. If that pessimism persists, she said, redemptions could exceed $8 billion in coming weeks as global investors seek safer bets.

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Greg Ip in Washington, John Lyons in Mexico City, Joanna Slater in New York and Steve Goldstein in London contributed to this article.

(See related article: "Loan Terms Tighten For Smaller Businesses; Recipe for Slower" -- WSJ Jan. 22, 2008)

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