US downgrade hits stocks as investors flee

NEW YORK: The fallout from Standard & Poor's downgrade of the United States pushed world stocks to their lowest level in nearly a year on Monday and drove investors to the safety of gold and bonds.

Strange as it may be, investors sought shelter in the asset that was downgraded -- choosing US government bonds for their liquidity and perception of the high quality of US credit.

Investors shunned stocks and commodities, struggling to discern the effects of the downgrade, which could hit various components of the financial sector, from mortgage lenders to municipal issuers and insurers.

US stocks lost more than 3 percent by midday and European stocks hit a 2-year low. Wall Street's favored gauge of investor anxiety briefly spiked above 40, a sign investors are afraid of more declines to come. The CBOE Volatility Index was up 21.1 percent at 38.76.

MSCI's all-country world stock index dropped 3.6 percent. The index was at its lowest level since September 2010. The sell-off since July 29 has wiped $3.4 trillion off the value of global stocks, the equivalent of Germany's gross domestic product.

"Everyone's hair is on fire," said Stephen Massocca, managing director at Wedbush Morgan in San Francisco.

The sell-off crowded out any relief from news that the European Central Bank was buying Italian and Spanish government bonds in the latest move to staunch the euro zone debt crisis.

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

Central to S&P's argument was that the political paralysis in Washington has reached a point where it 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.

"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 US equity strategist at UBS in New York.

"Now the market is really focusing on long-term sustainable growth issues and that is why you have the market taking it on the chin."

SEARCH FOR SAFETY

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

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

Investors looking for a safe place to park their money pushed gold to a record high above $1,700 an ounce. The dollar dropped against the Swiss franc and yen, while the euro fell.

The euro last traded at $1.4174, near a session low of $1.4150 on trading platform EBS and well off a session peak of $1.44320. The euro hit a record low against the Swiss franc, falling as low as 1.0640 Swiss francs.

The dollar fell 0.8 percent to 77.79 yen and was down 0.5 percent at 0.7635 Swiss franc.

The 30-year US Treasury bond was last up 3-3/32 in price and yielding 3.69 percent, down from 3.85 percent late on Friday. The 10-year Treasury note was last up 52/32 in price and yielding 2.38 percent, down from 2.57 percent late on Friday.

The Dow Jones industrial average dropped 309.62 points, or 2.71 percent, at 11,134.99. The Standard & Poor's 500 Index was down 42.52 points, or 3.55 percent, at 1,156.86. The Nasdaq Composite Index was down 94.29 points, or 3.72 percent, at 2,438.12.

European shares closed down 4 percent after earlier registering gains on the ECB action.

"The sell-off is mainly due to the fear that we will relapse into recession. Many investors have finally realized that the US economy will not grow at 3 percent," said Klaus Wiener, chief economist at Generali Investments, which manages 330 billion euros ($468 billion).

"I will attach a one-third probability to a renewed recession, not so much because it is fundamentally inherent in the system, but because the political risk has gone up."

Copyright Reuters, 2011