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, and 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?
At around $800 billion, European banks' exposure to Spanish debt is much greater than their $200 billion exposure in Greece, Joy says.
"If Spain has trouble, you'll have the same issues as in Greece, compounded by factor of four," Joy says.
Such a scenario would expose rifts that could threaten the unity of the EU, and further erode the value of the euro, he says.
Although the euro has been falling, the U.S. dollar has been rising. That can hurt stocks by cutting into profits of U.S. companies that do business abroad.
If the EU eventually breaks up over the debt troubles, global economic growth would take a hit. Joy said deflation, or falling prices, would be a likely outcome, eroding consumer and investor confidence.
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.
As for stocks, their comeback has been held back by the fears about Greece.
If those worries show no sign of subsiding, expect a return to the tiny yields that investors got from safer types of bonds such as Treasurys and short-term corporate bonds. They were favored when markets tanked in late 2008 with the Lehman Brothers collapse.
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 such as oil even if Europe's economy tanks.
"Emerging markets are pulling the developed world along when it comes to commodities," Horn said.
Greece's troubles also highlight the growing debt risks for governments globally -- a shift from 2008, when markets tanked largely on fears about corporate debt. That makes Horn especially wary of any big bets on government debt.
"This is the first time in my 30 years in the investment business that I have seen so many governments borrowing massive quantities at the same time," he said.
Europe's troubles point to the need for investors to balance their portfolio broadly, whether it comes to stocks versus bonds, or U.S. versus international, said Columbia Management's Joy.
Buckle up: And as markets have shown this week, expect more ups and downs, in contrast with the relative calm that had settled in over the past year. In such times, the chance for rash investment decisions grows -- think of the many investors who pulled out of stocks in early 2009 out of fear, only to miss the subsequent rally.
"You've got to prepare psychologically for these things to happen," Joy said, "so you're not forced into emotional decisions."