It's Europe, Stupid

The recent collapse in stock prices and Treasury yields in the U.S. was not related to any direct evidence that the U.S. economy was headed for a double-dip recession. It was mainly driven by fears of a European sovereign debt crisis that could potentially lead to a massive bank failure and a collapse of the Eurozone economy. With Europe already weak, a financial crash would likely bring the economy to its knees, and that in turn would be a serious drag on the U.S. economy. The chart above, which compares the S&P 500 index to its Eurozone counterpart, illustrates the dynamics. The recent Stoxx decline correlates highly (0.85) to the decline in the S&P 500, but the Stoxx index has fallen almost 20% more than the S&P 500 in the past six months. If investors are running scared here, they are in full-blown panic mode in Europe.