Despite an impressive stock rally Monday, Tuesday and Wednesday morning, the overall stock market careened down by the end of last week. The European banks sold off sharply Thursday, and then we had to retest the recent lows Friday. Since computerized trading systems like to “sell first and think second,” we saw big declines Thursday and Friday. As I’ll show you this week (below), I see this new retest as an overreaction to Europe’s banking crisis, not as a double-dip recession warning.

European Banks are the Major Cause of August’s Market Slump

I am amazed the financial media keep talking about the market’s latest decline as an advance signal of a double-dip recession, rather than as the failure of European banks to defend the euro. The current European crisis began July 21, with the second bailout of Greece and it escalated Aug. 2, when Italian bonds soared to astronomical yields. It’s no coincidence that our own market decline began Aug. 2!

Last week, French President Nicolas Sarkozy and German Chancellor Angela Merkel failed to agree on how to defend eurozone bonds. Merkel and Sarkozy pledged “euro unity,” but they ended up creating even more uncertainty. The fact of the matter is Germany is proud of its great credit rating and its ability to borrow at ultra-low interest rates, so Germany does not want to rescue the profligate Southern European “PIGS” (Portugal, Italy, Greece and Spain) and thereby taint its lofty credit ratings and healthy economy.

The fears of a weakening Europe were reinforced Tuesday when Destatis, Germany’s Federal Statistic Office, said Germany’s GDP rose only 0.1% in the second quarter compared to the first quarter, even though Germany’s GDP still is growing at a 2.7% annual rate. Destatis said “the dynamics of the German economy have cooled considerably after a racy start to the year.” But Germany continues to have a large backlog of orders, so its exports are expected to remain strong this quarter despite a flat second quarter.

Most major European banks — including France’s Societe Generale and Credit Agricole — already are 50% off their 2011 highs. On Thursday alone, Societe Generale fell 12% and Belgium’s Dexia lost 14% despite the ban against short-selling banking stocks in those markets. This recurring crisis in European banks last week triggered Wall Street’s computers to sell into thin volume, and the rout was on.