The Toronto Stock Exchange benchmark index closed with a loss of 392.50 points Thursday as global markets traded sharply lower and investors reacted to a pessimistic outlook for the global economy.

The S&P/TSX finished at 11,562.51, a loss of 3.28 per cent, a 14-month low. It was down 535 points at the day's low.

The TSX is down just over 19 per cent from its highs of early March. A 20 per cent drop signals that the market has entered bear market territory, or a period with general downward trend in share prices.

The Toronto Stock Exchange's metals and mining sub-index ended down 7.85 per cent, materials stocks — which include companies in forestry, chemicals and mining — fell 5.97 per cent and the global gold index lost five per cent.

On Wall Street, the Dow Jones industrial average took its steepest drop since Aug. 18, ending down 391.01 points, or 3.51 per cent, at 10,733.83, after falling as much as 527 points earlier in the session.

The Nasdaq composite index was off 82.52 points, or 3.25 per cent, at 2,455.67, and the S&P 500 fell 37.20 points, or 3.19 per cent, to 1,129.56.

The price of oil for November delivery closed down $5.41 US at $80.51 US per barrel on the New York Mercantile Exchange, while December gold ended $66.40 US lower at $1,741.70 US per ounce.

Money moves into bonds

In a bid to push down longer-term U.S. borrowing rates and spur the economy , the Fed on Wednesday unveiled a plan to exchange $400 billion US worth of short-term bonds for the same amount of longer-term bonds.

The Fed's plan, dubbed Operation Twist, had been expected, but the size of it surprised some as did the Fed's pessimistic language when it warned of "significant downside risks to the economic outlook."

"While Operation Twist was well anticipated, perhaps the severe warning from the Fed that 'there are significant downside risks to the economic outlook' was not," said Jane Foley, an analyst with Rabobank International.

David Baskin, president of Baskin Financial Services, told CBC News he disagreed, saying there was no significantly new information today to account for the sell-off.

"I don’t think we have any more information today than we had, say, a week ago at this time. I feel like the Fed stated the obvious in that there are significant risks to the world economy," he said.

And Europe may have improved slightly since then "because we’ve seen some positive moves in both Greece and Italy to get their government spending in order."

Hedge funds blamed

"I don’t see this as anything comparable to [the financial crisis] three years ago, he said.

A Global Rout

Thursday's selloff affected markets around the world:

Amsterdam -4.44%
Brazil -4.83%
Mexico -4.82%
Russia -7.82%
Spain -4.62%
Stockholm -4.88%
Switzerland -3.41%

"There is a tremendous amount of fear and uncertainly. It’s exacerbated by the 24-hours news cycle and the somewhat apocalyptic headlines and news flashes that one sees. And I think it’s also made worse by the prevalence of hedge funds in the marketplace that are anything but buy-and-hold investors, that are high-velocity traders. They’re in and out of positions very quickly and of course that adds volatility," Baskin said.

The Fed decided to purchase bonds that matured after 30 years, hoping to push down rates far into the future. That was at the far end of the bank's expected range of treasury purchases, and some investors think the bank might have maxed out its ability to have much influence on growth or interest rates.

Traders bought government debt instead of stocks, which are seen as comparatively risky. The yield the 10-year treasury bonds hit a record low, falling to 1.77 per cent from 1.86 late Wednesday. Yields fall when demand for treasury bonds rises.

Investors were also discouraged by rating agency Moody's downgrade yesterday of U.S. banks Bank of America, Citibank and Wells Fargo. Another ratings firm, Standard & Poor's, also downgraded seven Italian banks due to sovereign debt risk yesterday.

Data from China didn't help. Bank HSBC reported its preliminary China Manufacturing Purchasing Managers' Index fell to a two-month low in September.

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Europe’s debt crisis has increased the credit risk faced by European banks on loans to governments by €200 billion since the beginning of 2010, the International Monetary Fund said. (Alex Grimm/Reuters)

The New York Stock Exchange stepped in ahead of the opening bell to smooth out morning trading. The exchange used "Rule 48," a measure that limits the amount of information that's released about stock trades. 

It's designed to make trading easier and faster, and is only used on days when extreme volatility is expected. Dow futures had fallen nearly 300 points when NYSE invoked the rule.

European bourses also sold off amid more bad news about the state of the eurozone economy, with a closely watched survey from financial information company Markit suggesting a return to recession.

Markit's monthly purchasing managers index — a gauge of business activity — fell to 49.2 in September, its lowest level since July 2009, from 50.7 the previous month.

London's FTSE 100 index closed with a loss of 4.6 per cent, Frankfurt's DAX fell five per cent and the Paris CAC 40 retreated 5.3 per cent.

Asian stock markets were off sharply on Thursday. Japan's Nikkei 225 dropped 2.1 per cent to close at 8,560.26. South Korea's Kospi slid 2.9 per cent to 1,800.55. Australia's S&P/ASX 200 was 2.6 per cent down at 3,964.90. Hong Kong's Hang Seng had the biggest fall, diving over 900 points, or 4.9 per cent, to close at 17,911.90. The Shanghai Composite Index closed down 2.8 per cent at 2,443.06.

With files from The Canadian Press and The Associated Press