Downgrade Ignites a Global Selloff

U.S. NEWSAUGUST 9, 2011

Dow's 634.76-Point Plunge Is Worst Since '08 as Worries Rise About U.S. Economy; Asian Markets Drop at Open

By E.S. BROWNING

The downgrade of the U.S.'s credit rating sparked a global selloff on Monday, pushing the Dow Jones Industrial Average to its sharpest one-day decline since the financial crisis in 2008.

In scenes reminiscent of three years ago, selling accelerated as the day went on, and investors were forced to sell to meet margin calls from lenders demanding more collateral. The Dow ended the day down 634.76 points, or 5.5%, at 10809.85, its lowest close since last October. Trading volume of stocks listed on the New York Stock Exchange hit the fourth-highest level in history.

In Asia Tuesday morning, investors continued the global selloff with huge stock market losses and a rapid unwinding of currency and commodity bets. South Korea's Kospi Composite plunged 7.6% in morning trading, leaving it more than 20% lower since Aug. 1. Japan's Nikkei Stock Average traded more than 4% lower, and Hong Kong's Hang Seng was down 7% and below the 20000 level for the first time since July 2010. Australia's S&P/ASX 200 lost nearly 3%, putting the market there into bear territory, down more than 20% from its April 11 high.

Monday's Dow decline was its biggest percentage drop since December 2008 and its sixth-largest point decline ever. Other major stock indexes also fell heavily. Traders also dumped corporate bonds and industrial commodities.

Investors fled to the traditional refuges: gold, currencies of safe-seeming countries such as Switzerland, and, ironically, the very securities that Standard & Poor's downgraded on Friday, U.S. Treasury bonds. For most investors, Treasurys seemed a lot safer than stocks.

The Financial Stability Oversight Council, a group of U.S. regulators led by Treasury Secretary Timothy Geithner, held an emergency conference call Monday afternoon to discuss the financial-market volatility, a person familiar with the call said.

"There's probably as much uncertainty as we've seen since 2008," said Eric Pellicciaro of asset manager BlackRock's Fundamental Fixed Income division, which has $612.5 billion in assets under management. "There's a general feeling that policy options are few and far between. There's a feeling that fiscal austerity is coming at the worst possible time."

While there are no indications that the Federal Reserve intends to launch a new bond-buying program to support financial markets, investors are already speculating that the Fed may act in some way. Central-bank officials are set to meet Tuesday to discuss monetary policy.

During the afternoon, President Barack Obama spoke on television, and said the ratings downgrade should add a "renewed sense of urgency" for both political parties to tackle the debt and deficit. His remarks didn't quell the selling.

Market anxiety was reflected in a 50% rise in what traders call the "fear index"—a gauge known as the VIX, tracked by the Chicago Board Options Exchange, which measures investor use of options to guard against market declines. The VIX rose to 48, its highest close since March 2009, when the bear market was ending, and registered its biggest single-session percentage gain since 2007.

Reflecting a broad lack of confidence, European investors quickly moved on from optimism over a European Central Bank plan to support Spanish and Italian bonds. They turned their sights on France, which still has a triple-A credit rating, as a possible downgrade candidate.

S&P's move on the U.S. came at a fragile time for the market, which had been heading lower on worries about the U.S. economy and concerns about Europe's spiraling debt crisis.

Monday's decline marked the biggest three-day selloff since October 2008. The selling began on Thursday, before the downgrade, with a 512-point decline in the Dow.

Bank stocks bore much of the pressure Monday, with Bank of America Corp. dropping 20% and J.P. Morgan Chase & Co. falling 9%. Other household names that fell sharply included Alcoa Inc., down 11%, and Caterpillar Inc., which lost 9%.

But while some were tempted to liken the past few days to the depths of the financial crisis, investors pointed out key differences.

In 2008 and 2009, the selling focused heavily on financial stocks and bonds linked to the mortgage markets. This time, fears are broader, having to do with the risk of recession and of default by European borrowers, and the selling is broad-based.

At People's United Bank in Bridgeport, Conn., the 24 portfolio managers spent much of Monday reaching out to clients, armed with an internal memo that laid out reasons to stay cautious, but remain positive.

"One of the big distinctions that we have made is that 2008 was really a financial crisis and the events of last week are really a political crisis," said John Traynor, chief investment officer for the bank's wealth-management unit, which manages more than $3.5 billion and serves clients with between $1 million and $5 million in assets.

Still, the bank's advisers were discouraging customers from considering Monday's market plunge as a buying opportunity.

"There is enough uncertainty that if they have dry powder in their accounts, we don't feel there is a need to rush into the markets right now," Mr. Traynor said.

In Washington, regulators tried to understand the market turmoil and to prevent contagion. At the Treasury Department, officials spoke to investors and others, domestically and internationally. Mr. Geithner received regular updates, an official said.

On Monday, the stock selling affected almost every segment of the market, with all 500 stocks in the S&P 500-stock index declining, along with the 30 stocks in the Dow industrials.

"A lot of defensive stocks were down as much as aggressive stocks. That would indicate to us that there is panic selling in the market," said William Hackney, managing partner at Atlanta Capital Management, which oversees $14 billion in Atlanta.

Traders said the stock selling on Monday was driven in large part by hedge funds and large exchange-traded funds, especially those that use borrowed money to enhance their performance. When stocks fall suddenly, such funds are forced to sell assets to pay back some of their loans.

In midafternoon, traders said, some investment funds were hit with margin calls, or demands for additional collateral for loans they had taken for stock purchases. The need to raise cash for margin calls precipitated more selling.

Stocks that had been widely held by hedge funds were some of the biggest decliners, including Bank of America, Dendreon Corp. and Lear Corp. Stock and bond traders said it was sometimes hard to find buyers at all, which made some of the declines sharper.

While the S&P downgrade precipitated the selling, it intensified because of investors' lack of confidence in the economy and in the stability of world financial markets.

On days after big one-day selloffs, stocks often rebound as investors hunt for bargains, and some money managers said Monday that they were considering doing some bottom-fishing on Tuesday. The strength of any such rebound can be an indicator of the market's likely resilience over the coming weeks.