Oil's Drop and Economic Fears in Europe Hammer Stocks

By Brian Blackstone in Frankfurt, Tommy Stubbington in London and Min Zeng in New York 

        Stock markets around the globe tumbled as oil briefly fell below $50 a barrel and fresh worries arose about Europe's economy, stoking fears of SHYdeflation.
        The euro dropped to its lowest level against the dollar since 2006, reflecting concerns Greece could be headed for a messy exit from the common currency. Adding to pressure on the euro was a round of tepid inflation readings. That data raised expectations the European Central Bank will soon beef up its stimulus program, which investors interpreted as bearish for the euro.
        Major stock indexes fell 3% in France and Germany and 2% in Britain. U.S. stocks slumped, with the Dow Jones Industrial Average sliding 331.34 points, or 1.9%, to 17501.65, its largest point and percentage drop since Oct. 9. The retreat was led by steep declines in energy shares and a lesser pullback in large banks.
        Investors snapped up safer assets such as gold, which rose 1.5%, and government bonds. The yield on the 10-year U.S. Treasury note slid to 2.038%, its lowest since May 2013. Yields fall when prices rise.
        Roiling markets internationally were a host of economic and political indicators pointing to weakness and instability in Europe, despite signs of increased vigor in the U.S. economy.
        In Europe, an unexpectedly soft inflation report from Germany raised concerns the eurozone faces a potentially lengthy period of outright declines in consumer prices, which may make it harder for the region to recover from its lengthy economic slump.
        Low inflation or falling prices can have positive economic effects in the short term, particularly if they are driven by lower energy prices that free up cash to spend in other areas. The risk is that people expecting prices to hold steady or even fall might put off purchases or investments, leading to weaker economic activity overall.
        "The market fears that the oil-price decline is telling us something bad that we don't know about global growth," said Eric Stein, co-director of global income at money manager Eaton Vance Management, which has $297.7 billion in assets.
        Shares of several major European banks dropped 5% or more, highlighting concerns about the pace of growth on the Continent and the capacity of the eurozone's financial system to weather problems tied to Greece.
        Investors remain generally upbeat on the outlook for shares in the U.S. Even so, traders said drops of 3.1% in Morgan Stanley, Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. on Monday underscore fears that economic growth and profits will disappoint investors who have enjoyed a five-year-long rally in the S&P 500.
        "In the end, it is all about inflation," said Anthony Cronin, a Treasury-bond trader at Société Générale SA. "Falling oil prices are making investors nervous because the rest of the world is trying to avoid deflation."
        Expectations that central-bank action could be on the way this month have kept bond yields in the eurozone pinned close to record lows. Germany's 10-year bond was yielding just 0.5% Monday, while five-year German bonds yielded near zero, having dipped into negative territory Friday.
        Adding to Monday's tumult: German and French officials took a hard line against Greece, reigniting fears--largely dormant over the past two years--of a possible Greek exit from the euro.
        That is a destabilizing prospect for the 19-member currency bloc and its interconnected banks.
        "The No. 1 catalyst for this selloff is this nervousness about Greece," said James Swanson, a portfolio manager who oversees about $2.6 billion in stock and bond investments for MFS Investment Management.
        Greeks will vote in national elections Jan. 25, and a leftist party opposed to austerity measures imposed by the country's international creditors leads in the polls.
        Combined with worries about declining economic growth in other parts of the world, the revival of political and economic concerns in Europe underscored the risks confronting the $13.2 trillion eurozone economy just as the U.S. is showing signs of robust recovery.
        The annual rate of inflation in Germany, Europe's largest economy, was 0.1% in December, below economists' expectations and the weakest rise since the height of the global financial crisis in October 2009.
        Economists estimated eurozone-wide figures, due for release Wednesday, will show a 0.1% annual drop in consumer prices, which would the first negative reading in more than five years and far below the ECB's target of just under 2%. Last week, Spain's statistics institute said consumer prices in the eurozone's fourth-biggest economy fell 1.1% in December from the previous year.
        The German price data supported mounting expectations in financial markets that the ECB will launch large purchases of government bonds as soon as its next policy meeting on Jan. 22 to avert a debilitating slide into deflation.
        "Clearly, there's a high probability of negative inflation for the eurozone," said ING Bank economist Carsten Brzeski in Frankfurt. "It's increasing pressure on the ECB to act."
        With their inflation mandate increasingly at risk, ECB officials have fanned out in recent weeks, putting markets on notice that they are ready to purchase government bonds, if needed, to raise the money supply. They have also indicated that the first quarter is the likeliest time for such a move to occur.
        ECB President Mario Draghi said in a German newspaper interview last week that, although the risk of persistent price declines is limited, it can't be ruled out. "If inflation remains low for a long time, people might expect prices to fall even further and postpone their spending. We are not there yet. But we need to tackle this risk," he said.
        The concerns in Europe come as the price of oil has fallen by more than half since June. Crude futures on the New York Mercantile Exchange traded as low as $49.92 a barrel in intraday New York trading Monday, the lowest since April 2009, before settling at $50.04, down 5% on the day.
        Though the decline in oil prices has led to lower gasoline prices and boosted the fortunes of ordinary consumers, it has also curbed profits for the once-booming energy sector, which has grown in recent years to become a bigger part of the U.S. economy.
        Shares of Caterpillar Inc. dropped 5.3% following a J.P. Morgan downgrade that cited the company's exposure to energy, construction and emerging markets, all of which are seen as slowing down.
        Nicole Friedman and Dan Strumpf contributed to this article.
        Write to Brian Blackstone at brian.blackstone@wsj.com, Tommy Stubbington at tommy.stubbington@wsj.com and Min Zeng at min.zeng@wsj.com
        Access Investor Kit for Caterpillar, Inc.
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        (END) Dow Jones Newswires

        January 05, 2015 19:47 ET (00:47 GMT)

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