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'Chain of Dominoes' Giving Investors Cause For Worry

Wednesday, 19 May 2010 | 2:07 PM ET

As isolated events, the turbulence in the world markets probably wouldn't add up to much. But put everything together and you get a recipe for investor nausea.

CNBC.com

Global stocks have found any number of reasons lately to drop, be it worries over Greece's burdensome debt, newly announced trading rules in Germany, or expected tough financial regulations out of Washington.

It is the sum of their onerous parts, though, that has the markets worried, particularly over whether government involvement in trying to fix things will only make them worse.

"We've kind of kicked the can down the road. We haven't fundamentally addressed anything...and we're hoping that over time things will work themselves out," says Doug Roberts, chief investment strategist for Channel Capital Research. "What we're finding now is it's much more difficult because it's a global system. Everything is interlinked, so it's like a chain of dominoes."

Germany's ban on short selling, or betting that stocks will lose their value, was the latest tremor in the the markets. US stocks fell sharply in Wednesday trading, but European markets had losses more than doubling that.

Traders were somewhat puzzled over the market reaction, reasoning that a ban on short-selling might ordinarily lift the markets.

But experience from the early stages of the financial crisis, in September 2008 when Lehman Brothers failed, has resonated. The Securities and Exchange Commission on Sept. 18 announced a ban on short selling, a move that for a few days calmed the markets but only set the stage for an intensification of the market meltdown that had begun several months prior.

"It sucked confidence out of the market," Glenn Dubin, CEO at the Highbridge Capital hedge fund, said in a CNBC interview. "What Germany did was ill-advised. What we really need to do, what the policy makers need to do, is restore confidence in the market. The marketplace now questions, what is Germany trying to hide?"

Dubin said his firm is cutting risk, decreasing the size of its balance sheet and waiting for the waters to calm before stepping back in.

But with lingering problems like whether Greece's problems are only the first signal of what is to happen in other debt-laden European countries, finding safety anytime soon could be a tall task.

"People are reading into it that where there's smoke there's fire," says Dave Rovelli, managing director of US equity trading at Canaccord Adams. "If Greece is gone, it's a disaster. But if Spain or Portugal or Italy goes under" that would make things much worse.

Policy makers are not helping soothe investors' frayed nerves, and the German short-selling ban merely added to the jaundiced eye the markets are taking toward governments.

"It again suggests that the Germans are no closer to understanding that the markets are not the problem here," Simon Tilford, chief economist at the Centre for European Reform, told Reuters. "The markets are right to be uncertain about the sustainability of the euro zone in its current form."

The reaction to Europe's situation has been no better across the Atlantic.

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The Senate this week, in a rare display of bipartisanship, passed a measure seeking to put strict clamps on the way US contributions can be used in International Monetary Fund assistance to European Union nations.

The measure comes as the electorate is showing in election results that is in no mood to tolerate more bailouts.

"Right now it's deja-vu all over again. What people are wondering is if this is a repeat of what we did in 2008," Channel Capital's Roberts says. "You have a civil war that we fought 150 years ago being re-enacted in Europe only without the bullets."

Andrew Neale, portfolio manager at Fogel Neale Partners in New York, says investors are likely to continue to flock to safety, particularly high-grade bonds, and an aversion to risk as deflation continues to be the most likely scenariofor the US economy and turmoil most likely for overseas.

"There's a lot going on geopolitically and domestically right now," Neale says. "It's a complex market and its very confusing. When the market it is up it looks like it's going to go up forever and when it's down it looks like it's never going to stop going down. It's very schizophrenic right now."

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