The prospect of a U.S.-led attack on Syria dragged down stock markets worldwide, underscoring how rapidly the mood among investors has shifted after a long period of steady gains.
The U.S. benchmark index slumped to a seven-week low Tuesday, while prices for crude oil and gold surged higher.
Markets had already been fretting over multiple worries, ranging from a potential end to Federal Reserve stimulus and mixed U.S. economic news, to a possible debt-ceiling crisis in Washington, as well as the fact that stocks have enjoyed strong gains over the past year and may be vulnerable to a correction.
Now, reports suggest that the United States, France and the U.K. are preparing a response to the alleged use of chemical weapons in Syria, perhaps with military strikes, raising the level of investor jitters another notch.
"The market was very nervous and fragile to begin with," said Stephen Takacsy, chief investment officer at Lester Asset Management. "When you have something like Syria flaring up, it's an excuse to sell."
The S&P 500 fell 26.30 points or 1.6 per cent, closing at 1630.48, for its worst one-day dip in more than two months. Elsewhere, stocks also fell sharply. Losses in Europe were over 2 per cent and Canada's S&P/TSX composite index fell 169.09 points or 1.3 per cent, closing at 12,591.21.
Crude oil rose to an 18-month high of $108.92 (U.S.) a barrel, up $3, over concerns that military action against Syria could pull in other countries and disrupt energy exports from the Middle East.
Money flowed into havens such as government bonds and precious metals. The yield on the 10-year U.S. Treasury bond retreated to 2.71 per cent, marking its fourth straight decline. As yields fall, bond prices rise.
Gold rose above $1,415 an ounce to its highest level since May, adding to its total upward move of more than $200 an ounce since the end of June.
While concerns about intervention in Syria were largely blamed for Tuesday's turbulence, the market is also grappling with broader concerns.
Over the past week, a steep drop in U.S. new home sales and a disappointing reading on durable goods orders for July have rattled confidence in the recovery. Economic growth in the first and second quarters was anemic – at 1.1 per cent and 1.7 per cent, respectively – and the recent data suggest no pickup is imminent.
"All together, that probably puts some downside risk into the third-quarter growth forecast," said Robert Kavcic, senior economist at BMO Nesbitt Burns.
Stocks are also on edge over Fed policy, where the central bank has been preparing markets for an end to its bond-buying program, known as quantitative easing or QE.
Many observers believe the Fed will scale back its purchases of $85-billion a month as soon as September and end the program altogether by mid-2014, creating uncertainty over how stocks, bonds and the economy will react.
The yield on the 10-year U.S. Treasury bond recently rose to a 2-year high of 2.89 per cent, up from just 1.63 per cent in May – a remarkably sharp rise that could hit consumer borrowing and corporate profitability.
Even upbeat news on Tuesday came with caveats.
The S&P/Case-Shiller home price index showed that U.S. prices in June rose by more than 12 per cent year-over-year, but the gain looks like old news after the rise in borrowing costs since then.
As well, the Conference Board's consumer confidence index for the U.S. beat expectations, rising to 81.5, or near a five-and-a-half year high. However, Ian Shepherdson, chief economist at Pantheon Macroeconomics, expects the good mood won't last now that stocks have retreated from their highs.
"More importantly, we fear a collapse in confidence in October as Congress fights over the budget and debt ceiling, re-awakening all the 2011 fears over default and government shutdowns," he said in a note. "Confidence plunged back then; it could easily do so again."
While gloomy economic news could put the Fed off its intention to withdraw stimulus, it might not be what the stock market needs to move higher.
"I'm of the view that, at the end of the day, good economic news is actually good for the stock market, not the other way around," Mr. Kavcic said.