Torrent of EU news batters Wall Street

US stocks tumbled yesterday after investors were blindsided by a surprise call for a Greek referendum on an EU bailout plan, casting doubt on the sustainability of the recent market rally.

The S&P 500 has slid more than five per cent so far this week in moves reminiscent of the stomach-churning market swings seen over the past two months and after investors thought the worst of the Eurozone debt crisis was over.

The speedy pullback comes after stocks rebounded to post their best month in 20 years in October. The gains were fueled by hope for an eventual deal to rescue Greece, finally agreed upon at last week’s European Union summit.

“The fact that we gave it back as quick as we did in two days is very concerning,” said Ari Wald, an analyst at Brown Brothers Harriman.

“It looks very much as though it was a lot of short-covering, a lot of bears found themselves on the wrong side of the trade,” he said of the October rally.

Analysts said if Greek voters reject the unpopular bailout in a vote proposed by Greek Premier George Papandreou, it would likely result in a “hard default” by Greece, causing bigger losses for banks and raising the threat of systemic risk.

The news slammed European stocks, particularly the region's banks, which slumped six per cent. US banks were also hit hard. Morgan Stanley, which investors worry has heavy exposure to Europe, fell eight per cent.

The Dow Jones industrial average fell 297.05 points, or 2.48 per cent, at 11,657.96. The Standard & Poor’s 500 Index lost 35.02 points, or 2.79 per cent, at 1,218.28. The Nasdaq Composite Index dropped 77.45 points, or 2.89 per cent, at 2,606.96.

The selloff came on sharp spike in volume with 10.3bn shares traded on the NYSE, the Amex, and the Nasdaq, 22 per cent above its 20-day moving average, while the CBOE volatility index jumped 16 per cent to 34.77, its highest since around mid-October.

Nearly six stocks fell on the NYSE for every one that rose.

Adding to the gloom, factory activity in Asia’s big export economies slowed to the weakest rate in nearly three years in October, while UK manufacturing suffered a sharp decline, reigniting fears of a global slowdown.

The S&P 500 traded below its 14-day moving average for the first time since 7 October, pointing to a possible shift in short-term momentum.