Post-Brexit shudders ripple across financial markets

Last Updated Jul 5, 2016 4:14 PM EDT

U.S. stocks and Treasury yields dropped Tuesday, as investors continued to ponder the United Kingdom's decision to leave the European Union.

The S&P 500's financial sector, which has heavy exposure to U.K. markets, was also in decline.

"The Brexit stuff has to work its way through the system so we can figure out where fair value is going to be," JJ Kinahan told CBS MoneyWatch. "And we're coming into an earnings season where CEOs have to try to explain what this is going to mean for their companies when they don't even know."

"The market wants instant answers, and we're talking about a process that could take years," Kinahan added. "You can see the fear of the unknown by people buying fixed income so aggressively, it's a race for safety rather than yields."

The Dow Jones Industrial Average (I: DJI) lost 109 points, or 0.6 percent, to close at 17,841. The S&P 500 (SPX) fell 14 points, or 0.7 percent, to 2,089. The Nasdaq Composite (COMP) shed 40 points, or 0.8 percent, to 4,823.

Comments from Bank of England (BOE) Governor Mark Carney and data from the Commerce Department indicating soft demand for U.S. manufactured goods further dampened investor sentiment. Carney termed "challenging" the outlook for Britain's financial stability, with the BOE saying it would reduce the level of capital that banks must hold in reserve to let them keep lending.

Adding to the jitters on Tuesday was a halt in trading by three British financial firms -- Aviva Investors, Standard Life and M&G Investments -- after their investment units froze trading in their real estate funds following a demand by investors for their money back.

Mark Luschini, chief investment strategist at Janney Montgomery Scott, downplayed the moves as U.K.-specific, saying it makes sense that investors would be concerned about the commercial property space in Britain given the likelihood that European businesses could relocate out of Britain as a result of Brexit.

Investors are also watching for other possible symptoms of distress in Europe, with financial markets sensitive to signs of financial contagion on the continent. Reports that the Italian government may have to inject capital in Banca Monte dei Paschi di Siena, the country's third-largest lender, to offset bad loans sent the bank's stock down by double digits.

Italy is the fourth-biggest economy in the EU, so a banking crisis could heighten fears of slowing economic growth in Europe. Adding to those concerns is an October vote in Italy a slew of constitutional reforms. Experts say the referendum could bring down the country's government and trigger fresh elections, noting that Prime Minister Matteo Renzi has threatened to resign if the proposed changes are vote down.

Investors are looking at the fall referendum as a key political test, according to Morgan Stanley economists.

"So one could imagine a situation in which the referendum is taken as a vote against government policy, which is implementing structural change, but isn't reviving cyclical growth to a significant extent," they wrote in a note. "If the constitutional reform doesn't pass, this could set in motion a political crisis and put the structural reform process on hold."

Tuesday's declines in the U.S. follow a four-session winning streak for domestic equities, which had the S&P 500 tallying its best week since November.

The market rallied last week when it became evident that while Brexit "may have some fallout economically, it didn't spell the end of the world," said Luschini. "Now we're back facing the same issues," he added, citing factors that include uncertainty of the consequences of Brexit on earnings.