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Stocks sink on fears of fiscal gridlock and European instability

The stock sell-off on Wall Street reflects worries about looming federal budget cuts and the possibility of deepening economic turmoil in Europe.

February 26, 2013|By Walter Hamilton, Los Angeles Times
  • The Dow Jones industrial average sank more than 216 points Monday, a sign that the market’s strong advance early in the year is giving way to doubts about whether stock prices got ahead of economic underpinnings. Above, traders work on the floor of the New York Stock Exchange.
The Dow Jones industrial average sank more than 216 points Monday, a sign… (Spencer Platt, Getty Images )

The stock market suffered its worst drubbing of the year as investors grew worried about deepening fiscal gridlock in Washington and renewed political instability in Europe.

The Dow Jones industrial average sank more than 216 points, a sign that the market's strong advance early in the year is giving way to doubts about whether stock prices got ahead of economic underpinnings. It is an abrupt change from last week, when investors were expecting the stock market to hit record highs.

The immediate trigger to Monday's sell-off was a convoluted parliamentary election in Italy that failed to produce a definitive winner. The outcome stirred fear that the country may back away from self-imposed austerity measures favored by investors, and deepen Europe's economic turmoil.

Beyond that, the drop in the Dow was caused by jitters on Wall Street about looming federal budget cuts. Barring a last-minute deal between Congress and the Obama administration, billions of dollars of automatic spending cuts are scheduled to begin taking effect Friday in a range of government services.

The economic effect of the cuts is expected to be limited initially, and some experts think lawmakers will strike a compromise in coming weeks. Nevertheless, Wall Street doubted until recently that the spending cuts would kick in, and investors have been caught off-guard that so-called sequestration is now considered likely.

"The uncertainty attached to the sequestration is the biggest problem," said Hugh Johnson, who runs an investment firm in Albany, N.Y. "A lot of fairly savvy investors believed that sequestration was similar to the fiscal cliff — that it would be resolved and there would be a compromise and it wouldn't take place."

The $85 billion in budget cuts scheduled for this fiscal year would slash growth by about one-third and eliminate 750,000 American jobs, according to the Congressional Budget Office.

Not all investors are worried about potential cuts, saying they could boost the markets longer-term.

"Investors in general view sequestration as probably not the most elegant solution but as progress nonetheless," said Jack Ablin, chief investment officer of BMO Private Bank in Chicago. "Anything that cuts government spending and tries to close the budget gap is viewed as positive among investors."

The Dow slumped 216.40 points, or 1.6%, to 13,784.17. The blue-chip indicator is still up 5.2% in 2013. But the talk that permeated the markets in January, that the Dow and Standard & Poor's 500 index were poised to hit new all-time records, has been quieted for now.

The S&P fell 27.75 points, or 1.8%, to 1,487.85. The Nasdaq composite index declined 45.57 points, or 1.4%, to 3,116.25.

Italy's main stock index rose 0.7%, its second straight advance after falling sharply since late January.

No party won a majority in the Italian vote, but a faction strongly opposed to austerity won a surprising 25% of the vote in the lower house of Parliament.

The election renewed fears about a potential worsening of Europe's sovereign-debt crisis. The crisis pounded the financial markets in 2011 but had been quiet since the European Central Bank vowed last year to keep the Eurozone intact.

"The market is finally realizing that the fiscal imbalances in Europe aren't behind us necessarily and there are still many unsolved problems that have to be addressed," Ablin said. "European policy isn't necessarily made in parliament, but on the streets and in voting booths."

walter.hamilton@latimes.com

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