The fallout from Standard & Poor's downgrade of the US pushed world stocks to their lowest level in nearly a year on Monday and drove investors into 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 around 3 percent by late morning 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 18.1 percent to 37.79.

MSCI's all-country world stock index  dropped 3.3 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 US in the global economy and come as investors increasingly worry about another recession.   

Central to S&P's argument was that the political paralysis in Washington had 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.

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 dollar fell 0.8 percent to 77.79 yen and was down 0.5 percent at 0.7635 Swiss franc.
   
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, while the 30-year bond was last trading 84/32 points higher in price and yielding 3.71 percent, down from Friday's close at 3.85 percent.   

The Dow Jones industrial average fell 295.40 points, or 2.58 percent, at 11,149.21. The Standard & Poor's 500 Index was down 38.68 points, or 3.22 percent, at 1,160.70. The Nasdaq Composite Index was down 86.49 points, or 3.42 percent, at 2,445.92.

European shares provisionally closed down 3.4 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 U.S. 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."  - Reuters