Poof! Kiss investor confidence goodbye

NEW YORK (CNNMoney.com) -- Take a deep breath. Hold it in. Exhale. Feel better? No? Didn't think so.

Stocks were taking another hit Friday morning. Investors are still searching for a rational way to explain what the heck happened at 2:45 on Thursday. What really was the culprit for the sudden, massive plunge that sent the Dow down nearly 1000 points?

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Reaction to the startling images coming out of Greece? High-frequency computer trading run amok on Dow components Procter & Gamble (PG, Fortune 500) and 3M (MMM, Fortune 500) as well as Apple (AAPL, Fortune 500) and Accenture (ACN)? Human error due to a so-called fat finger by a Citigroup trader?

The Nasdaq, NYSE and Citi have all said they weren't responsible But you know what? No matter who's at fault, Thursday's mini-crash is a sad reminder of just how emotional and irrational investors can be.

There is still a lack of trust about the economic and market recovery. People simply don't believe that things are really getting better. All it took was the sight of the market in free-fall to cause a stampede for the exits and make the sell-off even worse.

To paraphrase a lyric from one of the better Sting solo tunes: On and on the market will fall. How fragile we are. How fragile we are.

For all the talk of the economy stabilizing, people are still thinking of those awful days of 2008 and many fear that Greece and the rest of the debt-ridden PIIGS nations of Europe can cause another global market meltdown along the lines of Lehman Brothers.

"Confidence is shaken. This reminds people of what they went through only a year and a half ago. It brought back all those lovely feelings," Karl Mills, the manager of the Counterpoint Select Fund and president and chief investment officer for Jurika Mills & Keifer in Oakland, Calif.

Mills said he did take advantage of Thursday's brutal rout to buy some shares of companies that he thinks are well-positioned to ride out the current market volatility. But he conceded that the European debt crisis, if not resolved soon, could slow the global recovery and perhaps even cause a double-dip recession.

Wasif Latif, a vice president of equity investments with USAA Investment Management in San Antonio, Tx., agreed that the problems in Europe have investors so spooked that they are dismissing evidence of a steady recovery in the U.S.

The government reported Friday morning that 290,000 jobs were added in April. That's the most in four years and it was also the fourth consecutive month of job growth. Still, none of that seems to matter right now.

"The unfolding Greek tragedy is getting all of investors' attention. It is overshadowing the relatively positive news about the U.S. economy," Latif said. "Yes, the numbers in the U.S. are stronger. But there's this fear of contagion."

So the sell-off of the past week could be the beginning of the long-awaited correction in the stock market. Stocks simply ran up too far too fast since the lows of March 2009. Many investors were pricing in a situation where the world's economic woes are over. That's not the case.

Even if the problems in Greece don't spill over and lead to a wave of defaults in Portugal, Spain, Italy and Ireland -- those proverbial PIIGS of Europe -- the debt woes should hammer home the fact that the global economy is going to recover slowly from the worst of the 2008 credit crisis.

There are going to be fits and starts, steps forward and back. Anyone sticking to the notion that there is going to be a rapid and robust rebound in the economy -- a so-called V-shaped recovery -- is deluding themselves.

"There is a huge disconnect between the stock market recovery and what's going on in the real economy," said Jack Reutemann, founder and CEO of Research Financial Strategies, an investment advisory firm based in Rockville, Md.

He pointed out that beyond the worries in Europe, the U.S. economy is still suffering from high unemployment, a massive foreclosure problem and an environment where small businesses still can't get loans from banks.

Reutemann said he doesn't think stocks will plummet all the way back to the depressed March 2009 lows. In other words, the PIIGS are not Lehman, part 2. But he does think that the S&P 500 could drift back to about 900, which is nearly 20% lower than current levels.

"I will grant that there have been some signs of improvement in the economy but the market run up was unsustainable," he said.

Reader comment of the week. It's amazing how quickly the tide has turned in the currency markets. It wasn't that long ago that people in Europe were talking about how pathetically weak the dollar was and that emerging markets like China might prefer the euro over the greenback.

Mark Elder remembers those days and made this remark in response to my Monday column about the dollar's strength against the euro in the wake of the Greek crisis.

"Ironic huh? -- I don't hear the Europeans looking down on the dollar now and boasting about the euro becoming the world's reserve currency!!"

- The opinions expressed in this commentary are solely those of Paul R. La Monica.