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GLOBAL MARKETS-Investors flee stocks for bonds on US downgrade

Published 08/08/2011, 04:38 PM
Updated 08/08/2011, 04:44 PM

* World stocks hit by losses, Wall St down 6 pct

* Worst day for S&P 500 since December 2008

* Gold hits record above $1,700 an ounce

* Italian, Spanish bond yields drop on ECB buying (Updates to U.S. close, adds details, quote)

By Leah Schnurr

NEW YORK, Aug 8 (Reuters) - U.S. stocks plunged on Monday, racking up their biggest losses in almost three years as investors fled to the safety of gold and bonds after the downgrade of the U.S. credit rating by Standard & Poor's stoked fears the country is falling back into recession.

Wall Street ended down more than 6 percent while European stocks hit a two-year low. A favored gauge of investor anxiety spiked in a sign investors are afraid of more declines to come. The CBOE Volatility Index <.VIX> surged 50 percent to 48.

The selling came in heavy trading, with volume of 17.5 billion shares on the New York Stock Exchange, NYSE Amex and Nasdaq, second only to the day after last year's sudden "flash crash."

Investors took shelter in the asset that was downgraded -- choosing U.S. government bonds for their liquidity and perceived high quality.

Investors were struggling to discern the effects of the U.S. credit rating downgrade to AA-plus from AAA, which could hit various components of the vast U.S. financial sector, from mortgage lenders to municipal issuers and insurers.

"It is a panic, and almost by definition it doesn't have an issue. It wouldn't matter what it was," said James Paulsen, chief investment strategist at Wells Capital Management, with over $340 billion in assets under management.

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The downgrade -- and threats of subsequent moves by S&P or other rating agencies -- raises uncertainty about the credibility of the United States in the global economy as investors worry about another recession.

Central to S&P's argument was that political paralysis in Washington has reached a point where the government would be unable to deal with worsening deficits and sagging economic growth. This burdens a stock market already skittish after last week's outbreak of fear.

U.S. President Barack Obama blamed the downgrade on political gridlock in Washington and said he would offer more recommendations on how to reduce federal deficits. For details, see [ID:nN1E7771BR]

"In many ways this is not about the downgrade. I think it's about the underlying fundamentals and issues that are embodied in the downgrade itself," said Jonathan Golub, chief U.S. equity strategist at UBS in New York.

MSCI's all-country world stock index <.MIWD00000PUS> dropped 5.1 percent to its lowest level since September 2010.

Monday's rush for the exits extinguished any relief from earlier news the European Central Bank was buying Italian and Spanish government bonds in the latest move to staunch the euro zone debt crisis. [ID:nLDE7770NM]

SEARCH FOR SAFETY

Several major brokerages have in recent days lowered their expectations for U.S. economic growth and share appreciation for 2011 and 2012.

Moody's repeated a warning it could downgrade the United States before 2013 if the fiscal or economic outlook weakened significantly. It said it saw the potential for a new deal in Washington to cut the budget deficit before then. [ID:nN1E77700L]

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The Dow Jones industrial average <.DJI> dropped 634.76 points, or 5.55 percent, to 10,809.85. The Standard & Poor's 500 Index <.SPX> slumped 79.92 points, or 6.66 percent, to 1,119.46. The Nasdaq Composite Index <.IXIC> skidded 174.72 points, or 6.90 percent, to 2,357.69.

It was the biggest drop for the S&P since December 2008.

Investors looking for a place to park their money pushed into gold, U.S. Treasuries and some safe-haven currencies.

Gold

"Treasuries are still a comparatively low-risk asset. I think there's no doubt about that," said Michael Schumacher, a strategist at UBS in Stamford, Connecticut.

The euro slumped to a record low of 1.0640 Swiss francs

The dollar

European shares closed down 4 percent after registering gains on the ECB action. The FTSEurofirst 300 index <.FTEU3> has lost about 21 percent since a peak in mid-February, putting it in bear market territory. (Additional reporting by Daniel Basis and Edward Krudy in New York and Atul Prakash and Jeremy Gaunt in London; Editing by Dan Grebler)

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