Wednesday, November 09, 2011

Sell-Off Fever Spreads to U.S. on Fears of Broader Crisis

Stock investors around the world have been bracing for the possibility that Europe would not be able to contain its sovereign debt crisis. On Wednesday, as the financial troubles deepened in Italy, it appeared their worst fears had come true.
Investors unleashed a sell-off in stocks across the board in Europe and the United States after bond yields in Italy, one of Europe’s largest economies, surpassed 7 percent, approaching the level that had sent other euro zone nations to seek bailouts.
The sweep started in Europe, where stocks on the major indexes ended down around 2 percent. The sell-off fever spread to the United States, where Wall Street opened sharply lower and never recovered, closing down more than 3 percent.
The euro tumbled, and Spanish and French bond yields also rose, amid fears that the contagion could spread further.
“Wednesday’s surge in Italian government bond yields has catapulted the euro-zone crisis into a dangerous new phase,” said John Higgins, a senior markets economist with Capital Economics, in a market commentary.
There had been hope that Italy would move aggressively before its own finances came under the kind of pressure that has led Greece, Ireland and Portugal to seek bailouts.
But investors have yet to see any signs of the policies that they say are needed to restore confidence. With pressure on his government growing, Silvio Berlusconi, the Italian prime minister, agreed late Tuesday to step down, but only after Parliament approves an austerity plan, prospects for which are currently unclear.
That has proved enough to make investors think that the problems of Italy and the euro will not be solved by his departure, especially as bickering political parties in Greece worked for a third day to form a new government able and ready to implement the painful measures needed to win funding from the European Union and International Monetary Fund.
“Despite the potential for change in some of the indebted euro zone countries, the underlying problems are still there,” Henk Potts, a fund manager at Barclays Stockbrokers in London, said. “At the moment there is just no credible plan for restoring market confidence.”
As a result, he said, “volatility remains the name of the game.”
The Italian developments sent stocks in the United States down from the opening bell, with losses deepening in the afternoon.
At 4 p.m., the Dow Jones industrial average was down more than 389 points, or 3.2 percent, at 11,780.94. The Standard & Poor’s 500 index was off 3.7 percent, at 1,229.10 and the Nasdaq composite index fell 3.9 percent to 2,621.65.
Bank stocks were hit the hardest. During the day, Morgan Stanley was down nearly 8 percent. Bank of America was down more than 4 percent, Citigroup was 7 percent lower and JPMorgan Chase declined more than 6 percent.
The euro slid to $1.3541, its lowest level for more than a month, from $1.3834 late Tuesday.
But distress in the financial markets was most apparent in bonds. With the yield on its 10-year bonds above 7 percent, Italy — faced with an aging population, slow growth and a large debt burden — will find it very difficult to repair its finances.
“The worry now is that Italy’s borrowing costs in the market will rise at a more alarming rate,” said Mr. Higgins.
He said that the rise in yields may have also been precipitated by the announcement of an increase in margin requirements for Italian government debt. He was referring to the move by LCH.Clearnet, the big European clearing house that trades in bonds, which raised to 11.65 percent the charge for trading Italian bonds due in seven to 10 years.
Traders said the European Central Bank was intervening in the bond market, buying Italian debt securities to hold yields down. But there is uncertainty about how much that can achieve.
Capital Economics estimates that the E.C.B. has already bought less than 5 percent of Italian government debt and needed to buy “hundreds of billions” more to make a difference, Mr. Higgins said. “We are skeptical it will be willing to do so.”
In addition to the exposure of banks to the turmoil in Europe, stocks were “caught in a tug of war” between slowing growth in China and decent corporate and economic data in the United States, said John Canally, an investment strategist and economist for LPL Financial.
“This uncertainty in Italy is just going to add to the volatility that we have already seen a lot of this year,” he said.
In Europe, the Euro Stoxx 50 index, a barometer of euro zone blue chips, closed down 2.3 percent, while the FTSE 100 index in London fell 1.9 percent. The Milan bourse led major indexes lower, dropping about 3.8 percent. Indexes in Germany and Paris were about 2 percent lower.
Investors fleeing euro-zone risk poured into the perceived safety of United States and German government bonds, driving their prices up and their yields down. The yield on the German 10-year bond fell 8 basis points to 1.7 percent, while the equivalent United States Treasury fell 11 basis points to 1.968 percent. A basis point is one-hundredth of a percent.
Mr. Potts said that even if economic growth was weak over all, corporate profits remained strong, and there was still hope for a market turnaround if European leaders could move aggressively to implementing the measures they have agreed on for rescuing the most-troubled euro members.
But there are market fears that such policies will not come quickly enough. Charles Reinhard, deputy chief investment officer at Morgan Stanley Smith Barney, said parts of Europe were already in a recession, while others were on the “cusp.”
“This will have knock-on effects for the United States economy,” he said at a news briefing.
David Jolly contributed reporting from Paris.

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