Why investors should care about Greek crisis

BOSTON - A financial tremor in one corner of the globe can leave cracks in an investment portfolio. It's a painful lesson just as many U.S. investors are regaining their confidence.

The stock market remained volatile on Wednesday. After falling 112 points earlier in the day, the Dow Jones industrial average closed down 60. It posted a two-day loss of 285 points.

The trigger is Greece, whose debt troubles threaten the pace of a global economic recovery. It's a growing concern even though the country's population is less than one-third of California's.

But the overriding issue is the financial health of Europe, and of an economic alliance on a continent that still matters despite faster growth in places like China and India. Investors worry that a $144 billion aid package for Greece won't be adequate to keep debt problems in Europe from spreading - not just there, but here as well.

In the short-term, investors trying to escape fallout from Greece have been shifting toward the safest types of bonds, with the trade-off of lower yields. What's more, they're exiting stocks, as seen in this week's sell-off. It's like late 2008, on a smaller scale.

"You're seeing something of a worldwide flight to safety," says David Joy, chief market strategist for Columbia Management, with $341 billion in assets.

The stock market rally that took hold in March 2009 has gone a long way to get investors back on track, but many have been late to latch onto stocks. For 27 consecutive months, safety-minded mutual fund investors have been plowing more money into bonds than into stocks, according to Morningstar Inc.

This year, investors have resumed a more typical pattern of putting more into stock funds than they've been pulling out.

"We're a year and half out of the crisis, which is usually the time it takes for people to become less panicky," says Avi Nachmany, research director of Strategic Insight.

So Greece's problems come at a difficult time. They present a challenge to investors testing the waters again, and raise questions for long-term players hoping for a sustained global economic comeback.

The Greek turmoil "should serve as a reminder that the ramifications of the financial crisis are still being felt," Joy says. The global economy's relatively quick recovery from a deep recession "should not lull investors into a false sense of complacency."

Here are some considerations:

• WHY A CRISIS? Although Greece is a bit player in global markets, its fiscal troubles and risks of a government bond default could set a precedent for how the European Union responds to less-immediate debt risks in Portugal, Spain and other shaky European economies.

The EU has struggled to reach a consensus on how far to go to bail out Greece, and Greek citizens who face the imposition of government cutbacks have taken to the streets in protest. The EU must balance the need to prevent Greece from defaulting, against the risk of encouraging similar fiscal irresponsibility by its member nations.

When a bailout agreement finally emerged over the weekend, investors in the U.S and elsewhere fretted about the ballooning size of the package. And if larger countries like Spain or Portugal end up needing bailouts as well, will the EU be able to afford it?

• SHORT-TERM PROSPECTS: Worries about a Greek default have caused investors to shift out of bonds carrying higher risk and longer maturities in favor of government-backed Treasurys. That means investors will see lower yields, as prices rise amid expectations of turmoil in the stock market. For example, on Wednesday, the benchmark 10-year note's yield dipped to its lowest level since December. Meanwhile, demand for bonds issued by U.S. financial companies that are big buyers of foreign government debt has been shrinking, depressing prices.

• LONG-TERM PROSPECTS: If Europe's troubles deepen, investors could shift more attention to emerging markets stocks as well as commodities.

Bernie Horn, manager of the $189 million Polaris Global Value Fund, likes commodities because he expects growing demand from countries like China and India will be able to sustain prices for essentials like oil even if Europe's economy tanks.