Stock plunge continues as European fears grow

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This post was updated with the market close at 1:12 p.m.

The Dow Jones industrial average closed sharply lower Wednesday, after plunging more than 400 points as fears grew that Europe’s debt crisis was wreaking havoc on the continent.

Traders worried about Italy’s ability to deal with its 1.9 trillion euros of debt, which was heightened by an anxiety-inducing report from Reuters that Germany and France may move ahead with a plan to shrink the number of countries using the euro.

The plan would be an effort to confront the European Union’s current inability to deal with the debt crises in Greece and Italy, but some leaders on the continent fear that it would have a destabilizing effect, according to Reuters.

The Dow ended Wednesday’s session down 389.24 points, or 3.2%, to 11,780.94. The Standard & Poor’s 500 index was down 3.7%, or 46.82 points, to 1,229.12.

The Dow’s drop was its largest since it fell 391 points on Sept. 22. But the sell-off just pushed the index back to where it was on Nov. 1.

On Tuesday, investors had taken heart from news that Silvio Berlusconi would step down as Italian prime minister after a long, rocky tenure. But on Wednesday the focus shifted from Berlusconi to the problems that Italy will continue to have, no matter who is leading the country.

‘You’ve got a collision of raw nerves by investors and a lot of news out of Europe,’ said Keith Wirtz, chief investment officer at Fifth Third Asset Management in Cincinnati.

Aside from the news itself, the up-and-down nature of Europe’s financial woes -- appearing to be resolved only to flare again -- is wearing on investors, Wirth said.

‘It’s almost like watching a scary movie where you think the bad person is dead and they pop back up again,’ Wirth said.

Yields on Italian government bonds rose to recent records Wednesday, signaling the distrust that investors have in Italy’s ability to repay its debts.

The market yield on 10-year Italian bonds soared to 7.25%, up from 6.77% on Tuesday and the highest since 1997. The yield has surged from 5.93% just two weeks ago.

As investors fled European markets, they poured again into U.S. Treasury bonds, sending the yield on the 10-year Treasury bond below 2%. The dollar gained in value against the euro.

Just a week ago, investors were breathing a sigh of relief as the European Union appeared to develop a package to bail out Greece from its debt crisis. Attention has now swiftly turned to the problems in Italy, which is much larger than Greece. With its 1.9-trillion-euro debt, most analysts say Italy is too big for the European Union to bail out. Without a bailout, Italy could default on its bonds, sending shock waves through the international financial system.

There are also questions about how willing Berlusconi will be to relinquish power, and how smooth any transition will be.

‘Berlusconi’s announcement that he would resign once the government votes through economic reforms demanded by the European Union does not appear to have had the desired effect on market sentiment,’ analysts at Nomura Securities wrote in a note to clients Wednesday morning. ‘It has become clear that the saga could run well beyond the vote on the 2012 budget law next Tuesday.’

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-- Nathaniel Popper and Walter Hamilton
Twitter.com/nathanielpopper

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