So much for euphoria.

Having soared just days ago on a pledge by European leaders to prop up euro zone banks and stem the spread of a festering debt crisis, world stock markets and the euro came crashing back to earth this week as Greece's government hovered near collapse.

The decision by Greece's prime minister to subject a just-agreed bailout to referendum was the last thing markets wanted to hear.

A defeat by Greek voters could see Greece ejected from the euro zone and thrust into default, a scenario investors fear could spark a run on banks that have lent money to troubled European states.

Investors, faced with such risks, may opt to pack it in for the year and live to trade another day.

We're seeing moves in one day that in normal times we would see in the course of a year, said Quincy Krosby, market analyst at Prudential Financial in Newark. That makes for a very difficult market to navigate.

It hasn't been a robust year to begin with -- the S&P 500 is down 2.8 percent so far in 2011.

Andrew Busch, a currency and public policy strategist at BMO Capital Markets in Chicago, compared the market's swings to teenagers in love.

One day, they're in a euphoric state, holding hands. The next there's an ugly breakup, he said. The longer that goes on, he added, the more inclined investors will be to park their money in U.S. Treasuries and sit things out for a few rounds.

There were signs of that Tuesday. U.S. stocks tumbled a day after the benchmark Standard & Poor's 500 index wrapped up its best month in 20 years. The euro lost 1.1 percent on Tuesday, interrupting a long rally for the single currency. U.S. Treasuries, widely sought as safe havens in times of stress, rose as the 10-year yield fell below 2 percent.

Scott Mather, a portfolio manager at PIMCO, the world's largest bond fund with assets of $1.2 trillion, said he would not be surprised to see the 10-year yield fall to 1.50 percent or less by year-end on concerns about Europe, a still sluggish U.S. economy and signs of fatigue in the Chinese economy.

The uncertainty could force institutions to remain conservative or grow more reticent about adding to risk. Global portfolio managers cut equity holdings to the second lowest level in 12 months in October, Reuters polls showed on Monday.

At some point, they may abandon (positions) given everything that's going and just take risk off the table, he said. That could have a meaningful impact on markets.

LOTS TO BE WORRIED ABOUT

A big risk for investors, Busch said, is the speed at which markets react when anxiety runs high. The demise of MF Global Holdings Ltd, the brokerage run by former Goldman Sachs Group chief and New Jersey governor Jon Corzine, is a case in point.

Once market unease about the firm's exposure to European debt spread, it took less than a week for it to be forced into bankruptcy and put pressure on bank shares around the world.

It's astonishing how fast things move. The alacrity with which people can want to sell a stock that has any connection to Europe or other problems is a cautionary tale, Busch said.

Other warning signs are flashing, too. October factory activity in China, an important engine of global growth in recent years, fell to its lowest level since early 2009, hit by a decline in export orders from Europe.

That prompted Australia to cut its benchmark interest rate for the first time in more than two years. Australia is a major raw materials supplier for China and has been something of a leading indicator on monetary policy and global growth.

While recent data suggests the U.S. economy may be able to skirt recession, economists say growth remains too sluggish to make a dent in a 9.1 percent jobless rate.

Even if Europe wasn't the standout cause of concern, there's still plenty to be worried about Mather said.

If investor risk aversion grows, life will get challenging for policymakers as well. In Japan, investors who exit risky trades and bring money back home for safekeeping strengthen the yen while hurting the country's export sector and economy.

Some say that makes intervening to weaken the yen, something the Japanese government did this week for the third time this year, an expensive and ultimately futile exercise.

Bank of Japan data suggests the government spent nearly $99 billion on Monday to weaken the currency.

Our outlook calls for substantial volatility in all currencies, except for possibly the yen. As such, our risk assessment is currently favoring the yen disproportionally, said Axel Merk, who manages the $750 million Merk Hard Currency Fund in Palo Alto, California.

FINDING THE OPPORTUNITIES

But Brian Belski, chief investment strategist at Oppenheimer & Co, said those who get too gloomy risk missing opportunities, such as stocks that offer higher dividend yields than safe-haven Treasuries.

Reports Tuesday afternoon that Greece might abandon a referendum on the bailout caused stocks and the euro to pare losses and knocked some of the wind out of bonds.

All of us -- hedge funds, mutual funds, mom-and-pop operations -- are at the mercy of the sound bite right now. There's a lot of fear, said Belski, who expects the S&P 500 to end the year at 1,325, up from around 1,218 on Tuesday.

What's going on right now is a classic study in investor psychology.

(Editing by Padraic Cassidy)

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