Stocks were on course for their worst quarter in three years on Friday as economic data from China and Europe fueled fears of a global economic slowdown while Morgan Stanley plummeted on concerns about its exposure to European banks.

Equities were heading for a fifth monthly fall and their worst quarter since the height of the credit crunch in the fourth quarter of 2008. The S&P 500 index has lost nearly than 13 percent this quarter and 6 percent in September alone.

Stocks have been battered by signs of an global economic slowdown and fears that a debt default by Greece could spark a credit shock similar to that caused by the collapse of Lehman Brothers in September 2008, sending markets into a tailspin.

Financial shares stumbled with Morgan Stanley, which was off 7.6 percent to $13.95 as investors appeared to react to fear signals in credit markets. The cost of insuring Morgan Stanley's five-year bonds spiked in recent days to almost three times what it was on June 30. It shares have erased all their gains of the last three year.

There is a lot of fear that GDP growth is going to slow down, or it's not going to be as fast as consensus estimates assume, said Adam Krejcik, an analyst at Roth Capital in Newport Beach, California. Generally speaking there is a lot of fear out there, just a crisis of confidence.

The Dow Jones industrial average dropped 123.89 points, or 1.11 percent, to 11,030.09. The Standard & Poor's 500 Index fell 15.75 points, or 1.36 percent, to 1,144.65. The Nasdaq Composite Index lost 37.56 points, or 1.51 percent, to 2,443.20.

Wall Street's fear gauge, the CBOE volatility index, or VIX, rose more than 5 percent above 40, indicating investors expect more volatility.

China's manufacturing shrank for the third month in a row and the longest contractional streak since 2009 in a troubling sign for the world economy, which has looked to China as a rare source of expansion.

Through Thursday, the MSCI All Country World Index had lost about $4.7 trillion in market capitalization and the S&P 500 has lost about $1.45 trillion in market cap during this quarter.

Euro zone annual consumer prices unexpectedly rose in September to 3.0 percent, data showed on Friday, and followed surprisingly higher inflation in Germany.

In what may be a precursor to the quarterly earnings season, Ingersoll Rand Plc tumbled 13.2 percent to $27.73 after the industrial conglomerate cut its third-quarter and full-year earnings forecast to below market estimates. The Morgan Stanley cyclical index dropped 3 percent.

Markets showed little reaction two U.S. economic reports that were stronger than analysts expected.

Business activity in the U.S. Midwest grew more than expected in September, buoyed by new orders and a jump in employment.

The Institute for Supply Management-Chicago business barometer surprisingly rose to 60.4 in September from 56.5 in August. Economists had forecast a September reading of 55.5.

U.S. consumer sentiment improved in late September but worries persisted about jobs and finances, which could curb household spending in the coming months, the Thomson Reuters/University of Michigan final September reading of the overall index on consumer sentiment showed.

(Additional reporting by Himank Sharma; Editing by Kenneth Barry)