Investors are again worried that debt problems in Greece and Portugal could threaten the global economic recovery.
Stocks plunged in the U.S. and Europe Tuesday after Standard & Poor's downgraded the debt of the two European countries. The Dow Jones industrial average fell 213 points, its biggest loss in almost three months. All the major market indexes were down about 2 percent.
The ratings downgrades also sent the dollar up more than 1.1 percent against the euro, hitting its highest level in about a year. At the same time, gold and Treasury prices rose as investors sought safer investments. The three often do not trade in the same direction.
"It was a knee-jerk reaction," said Brian Peardon, a wealth adviser at Harrison Financial Group in Citrus Heights, Calif. Peardon said the small size of Greece and Portugal's economies mean their debt struggles are not yet a major problem. But if they were to default on their debt, other countries that hold their bonds would also suffer.
Debt-strapped countries would also likely find it harder to spend more to stimulate their economies and help feed the global economic recovery.
Standard & Poor's downgraded Greece's debt to junk status and lowered Portugal's debt two notches to A-minus from A-plus. Greece has already admitted it can't pay debts coming due shortly and it has asked for a bailout from European neighbors and the International Monetary Fund. And there are growing concerns about Portugal's ability to handle its debts.
Investors have been on edge for months about Greece's fiscal crisis even as they've sent stocks higher on signs of an improving U.S. economy. They have also been worried that Portugal could be the next European country to need help. That has undermined confidence in the euro, and raised questions about whether some of the 16 nations that share the currency might abandon it.
"This is a major test case for the euro," said Quincy Krosby, a market strategist with Prudential Financial. The European Union "needs a viable template on how to deal with these issues," Krosby added, noting that troubles extend beyond just Greece.
The drop in the euro can be a problem for U.S. companies that do business in Europe. When the dollar is up against the currency, the profits they earn in European countries translate to fewer dollars and can cause a dip in earnings.
Greece agreed last week to tap a rescue package from the euro nations and the International Monetary Fund. However, there are now worries that Greece won't have access to the money before it is forced to make a big debt repayment on May 19.
A setback in the European economic recovery "sends a U.S. recovery back and spreads to emerging markets," said Eric Thorne, an investment adviser at Bryn Mawr Trust Wealth Management in Bryn Mawr, Pa.
The debt problems have the potential "to have devastating effects," Thorne said. Thorne noted, however, he doesn't yet predict a worst-case scenario that would put a global recovery completely on hold.
Tuesday's downgrades overshadowed a jump in consumer confidence and the latest upbeat earnings reports from U.S. companies including 3M and Dupont. Still, many analysts, noting that the market has been going up almost relentlessly the past two months, have said stocks were due for a pullback.
The news about Greece and Portugal also drew some of the market's attention away from testimony by Goldman Sachs CEO Lloyd Blankfein and other top executives from the bank on Capitol Hill. The executives testified about the company's dealings in mortgage-backed securities during the credit crisis.
The Securities and Exchange Commission has charged Goldman with civil fraud, accusing it of misleading investors about investments tied to subprime mortgages.
Goldman was actually one of the relatively few winning stocks Tuesday. Analysts said investors were reassured by the fact there were few new details in the testimony. The stock rose $1.01, or 0.7 percent, to $153.04.
The Dow fell 213.04, or 1.9 percent, to 10,991.99. It was the biggest drop for the average since it fell 268.37 on Feb. 4, also amid concerns about European debt problems.
The Standard & Poor's 500 index fell 28.34, or 2.3 percent, to 1,183.71, while the Nasdaq composite index dropped 51.48, or 2 percent, to 2,471.47.
Only 498 stocks rose on the New York Stock Exchange, while 2,592 fell. Volume came to a heavy 1.68 billion shares, compared with 1.2 billion Monday. It picked up markedly when news of the ratings downgrades came out.
Portugal's main stock index dropped 5.4 percent, while Greece's plummeted 6 percent. Britain's FTSE 100 fell 2.6 percent, Germany's DAX index dropped 2.7 percent, and France's CAC-40 tumbled 2.8 percent.
The Chicago Board Options Exchange's Volatility Index, known as the market's fear gauge, surged 30.6 percent. It often jumps when investors become rattled. Still, at about 22, it is far below the 89 that it reached in October 2008, at the height of the financial crisis.
Bond prices surged as investors sought safety in U.S. government-backed debt. The yield on the benchmark 10-year Treasury note, which moves opposite to its price, fell to 3.69 percent from 3.81 percent late Monday.
The Russell 2000 index of smaller companies fell 17.59, or 2.4 percent, to 721.27.
Dow components 3M Co. and Dupont Co. both reported better-than-expected first-quarter profits. The pair also boosted their earnings outlooks for the year based on improving sales and a rebounding economy.
3M shares rose 53 cents to $87.97, while DuPont dropped $1.55, or 3.7 percent, to $39.42.
The Conference Board's consumer confidence index jumped to 57.9 in April. Economists polled by Thomson Reuters had forecast it would rise to 53.5.
On Wednesday, the market will be watching the Federal Reserve, which will end a two-day, rate-setting meeting. The Fed has said it plans to keep rates at historic lows for an extended time to help the recovery. However, eventually rates will need to climb to fight inflation as the economic rebound continues. Investors are hoping the Fed will hold off on raising rates for some time.