Stocks end up on hopes of Europe deal

NEW YORK -- Headlines out of debt-weakened Europe are fast becoming the main market-moving information nuggets on Wall Street, eclipsing more traditional buy-and-sell signals such as P-E ratios, corporate earnings and interest rates.

For the second straight day, U.S. stocks rallied sharply on Tuesday amid hopes that policy makers in Europe would heed urgent calls from leaders of some of the world's most influential economies, including the U.S., for swift and bold action to limit the economic fallout from the euro zone's debt crisis. Stocks are now up for three consecutive sessions.

"Europe is the story," says Nicholas Sargen, chief investment officer at Fort Washington Investment Advisors. "We are in a type of market where you can have big swings, (due) to optimism or pessimism based on whether Europe is resolving its sovereign debt and banking problem."

In short, if the news out of Europe is good, stocks go up. If the news is bad, it spells trouble for stocks.

On Tuesday, optimism was on display for most of the session, as the Dow Jones industrials gained 147 points, or 1.3%, to 11,191, although larger earlier gains slipped away late on a report of sour news out of Europe. The Dow rose 272 points Monday.

Tuesday's trading session illustrated the yo-yo-like mood shift that is driven by incoming news reports from Europe.

The Dow was up by as many as 325 point, amid optimism that European leaders have "finally gotten the message," delivered by members of the International Monetary Fund over the weekend, that the euro zone needs to recapitalize its banks and increase the size of its bailout fund created to aid sovereign governments like Greece that have crushing debt loads, says Joseph Quinlan, chief market strategist at U.S. Trust.

"Investors are trading off the hope that Europe will move quicker, faster and more dramatically," to do what is necessary to ensure that Greece's problems don't spread to other European countries and beyond, says Quinlan.

But the Dow gave up more than half of its gains late in the day after the Financial Times reported that a "split" had developed among the 17 euro zone members over the term's of Greece's second bailout, which is needed to avoid default next month. The selloff was reminiscent of last week's 6.4% Dow plunge, which was driven in part by fears of a global economic slowdown due to problems in Europe.

Europe matters to U.S. investors because if a disorderly default of Greece occurs, it could cause a negative domino effect that could cause a systemic banking crisis in the euro zone, increase the chances of a global recession and spread the financial contagion across the ocean and tip the U.S. into a double-dip recession.

"Most of the downside risks for the global economy and markets is focused on the euro zone," says Bill Stone, chief investment strategist at PNC Wealth Management. "Right now investors are trading on hope, because we have not seen concrete actions out of Europe, just reports of various potential policy actions."

Despite the two-day rally, investors must be prepared for the potential for markets to tank if news out of Europe again fails to live up to market expectations, says Alec Young, global equity strategist at S&P Capital IQ. "It is extremely complex and there is still a lot of heavy lifting to do," he says.