Europe woes weigh heavy on U.S. stock markets

— -- For U.S. investors, the worsening European financial crisis is going from an Old World sideshow to the main event.

Recent news, including the resignation of the European Central Bank's chief economist late last week and fresh rumors about a possible Greek default, are feeding investors' imaginations on how precarious the situation there is.

U.S. investors, already worried about domestic problems, wonder if a European spillover will make things worse for a fragile U.S. economy. If Greece defaults, it could imperil European banks that hold its bonds and tip Europe into recession. U.S. companies would feel the shock waves because they get substantial revenue from Europe.

Europe is the biggest overhang on U.S. stocks, trumping even concerns about anemic job growth in the U.S., says Liz Ann Sonders, chief investment strategist at Charles Schwab. The reason: There is a "real possibility" that Greece will default on its debt.

"It's front and center now, and a default could come sooner rather than later," Sonders says. "The bottom line is no one has the full ability to calculate the implications of a Greek default."

But investors aren't wasting any time trying to figure it out, and dire speculation is winning. The Dow Jones industrial average sank 304 points to 10,992 Friday, the worst point decline since it fell 420 points on Aug. 18 on the heels of Europe bank worries and an economic indicator that fell to recessionlike levels.

Investors are getting accustomed to events in Europe taking U.S. stocks hostage.

The Dow swooned 101 points Tuesday on woes in Europe but rebounded 276 points a day later when a German court approved Germany's bailout payments to struggling sovereign nations.

Similarly, a two-day bust-and-boom stock reaction occurred in mid-August. The Dow plunged nearly 520 points on Aug. 10 amid rumors that French banking giant Societe Generale was in deep financial trouble. But the Dow rallied 423 points the next day when those market rumors were proved false.

Many U.S. investors are incorrectly assuming European policymakers are powerless to stem a Greek default if it occurs, says Samy Muaddi of T. Rowe Price. "The ECB has a fairly big tool kit that's not being used at the moment," he says.

Greece dismissed rumors of a default Friday, saying it's committed to its July agreement to obtain a second bailout package from the European Union and the International Monetary Fund.

Given the uncertainty, it's understandable how investors might worry that the situation starting with Greece could infect other countries such as Italy and Spain, says Scott Mather of investment firm Pimco.

"Most European banks are in pretty good shape. If just Greece and Portugal default, most banks will do pretty well in Europe. The real problem is that people extrapolate from there to Italy and Spain," he says. "The market is in a 'show me' state of mind. It needs to see the actions rather than the words."