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European recession fears put US stock rally at risk

By Nathaniel Popper, Los Angeles Times –

NEW YORK — Renewed fears of a European recession are threatening to derail the stock market’s 2012 rally.

Stock indexes around the world experienced their sharpest drops of the year Tuesday, with the Dow Jones industrial average logging its first triple-digit loss since December.

In the past five months the blue-chip index has risen more than 20 percent to its highest point since before the financial crisis, driven by good economic data in the U.S. and growing hope that European leaders had contained the debt crisis there.

Now the fear is that investors have gone too far. Sentiment turned negative as higher oil prices threatened to put a damper on U.S. consumer spending, and China scaled back its own estimates for economic growth.

The sell-off on Wall Street was set off by reports that the European economy has entered into a recession that could grow worse if a Greek rescue plan fails this week.

“We’ve been watching and waiting for some level of pullback for some time,” said Chris Konstantinos, the director of risk strategy at Riverfront Investment Group. “It’s no surprise that some disappointing economic news from Europe would be the catalyst for a sell-off.”

The Dow ended Tuesday down 203.66 points, or 1.6 percent, at 12,759.15. That is the worst single-day drop since Nov. 23 of last year and brings it well below the psychologically important 13,000-point barrier crossed last week. The broader Standard & Poor’s 500 index finished the day down 1.5 percent, or 20.97 points, to 1,343.36.

Stocks were launched higher late last year after European leaders worked out a deal to help lower Greece’s debt burden. But concerns about the deal have been revived ahead of a decisive deadline Thursday. Holders of Greek bonds are being asked to trade in their old Greek bonds for new bonds that are worth less.

If enough bond holders buy in, Greece will be able to lower its debt and continue borrowing money on the bond market. But Greek leaders have indicated that if 75 percent of bondholders do not sign on to the plan, the country may default on debt payments this month.

Investors were spooked after a confidential memo on a potential Greek default surfaced Tuesday from an industry group representing bondholders. The International Institute of Finance said that the consequences of such a default could be $1.3 trillion in losses to the European economy.

“When combined with the strong likelihood that a disorderly Greek default would lead to the hurried exit of Greece from the Euro Area, this financial shock to the (European Central Bank) could raise significant stability issues about the monetary union,” the institute’s memo said, according to a copy posted on a Greek news website.

Fears of a European slump were heightened Tuesday when the European Union reported that the region is already in recession, with the economy shrinking 0.3 percent in the fourth quarter of last year.

As has been typical during other recent market slides, investors sought the safety of U.S. Treasury bonds and piled out of bank stocks, which would have the most exposure to a Greek default.

Aside from the threats of Europe, economists have worried in recent weeks that the U.S. economy could be susceptible to a continuing rise in gasoline prices, especially if the crisis between Israel and Iran escalates.

Still, market analysts say it is too soon to declare the market’s recent rally over.

European leaders have generally found a way to overcome past crises, and banks have been carefully preparing for the worst-case scenario with Greece.

In the U.S. a number of upcoming events could help generate more optimism about the economy, including Wednesday’s expected announcement of a new iPad from Apple Inc. and Friday’s monthly employment report.

But after the incredible surge in share prices in recent months, even market bulls are expecting stocks to take at least a short-term break before rising any further.

“You get the sense — maybe we got a little ahead of ourselves,” said Marc Pado, the U.S. market strategist at investment advisory firm DowBull. “It’s not panic time.”

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