It was the week of the defensive crouch. In the face of wrenching global economic and political events, many traders, corporate treasurers and pension managers decided that cash and U.S. Treasuries were the safest places to be.
The S&P 500 absorbed its worst one week decline since November 2008 as concerns grew about the inability of world political leaders to deal with the European debt crisis or the faltering U.S. economic recovery.
And even though the S&P and other U.S. stock indices closed Friday either modestly higher or lower, the flight to safety in the form of cold hard cash is one that seems unlikely to end anytime soon.
Volatile trading is likely to continue until investors see some credible plan for dealing with the sovereign debt crisis plaguing Greece, Ireland, Portugal, Spain and now Italy.
Money managers also say the toxic battle in Washington over raising the nation's debt ceiling, which led to the threat of a default, has left them doubting the ability of U.S. politicians to work together to jump-start the economy.
"I feel like I've been through the ringer," says Joelle Mevi, the chief investment officer of the Public Employees Retirement Association of New Mexico, commenting on this week's Wall Street slide.
Mevi says she's become "less optimistic" about the U.S. economy and is moving to sell some of the $11.6 billion pension fund's stock holdings to double the fund's cash reserve to $200 million. She notes that normally her New Mexico pension fund keeps nothing in cash.
Clearly, she isn't alone in thinking about lightening up on stocks. Individual investors pulled some $7.5 billion out of U.S. stock mutual funds during the week ending Aug. 3, which was the highest weekly outflow from stocks since mid-August 2010, according to Lipper data.
A number of traders say European financial institutions also were selling U.S. stocks to build up cash reserves in light of the mounting sovereign debt problems overseas.
And large U.S. corporations, already hoarding nearly $1.2 trillion in cash, are still beefing-up their balance sheets. In a conference call with investors Friday, MetLife Chief Investment Officer Steve Goulart said the large insurer recently "added several billion dollars of excess cash" to its reserves.
"We think it is a prudent thing to do in an environment of uncertainty that exists today," said Goulart.
Companies are moving money into non-interest-paying bank accounts that carry an unlimited guarantee from the Federal Deposit Insurance Corp. The accounts, set-up by Congress last year to provide added assurance to businesses in the event of a bank failure, carry unlimited FDIC insurance.
One of those companies using the new FDIC non-interest bearing accounts is the maker of glass for televisions, Corning Inc ., which moved $1 billion into one account during the middle of the debt ceiling crisis as a safe haven.
Corning Treasurer Mark Rogus says even though the debt ceiling dispute is over, the company intends to keep its $1 billion there so it doesn't "have to worry about market movements."
The rush to cash has been so great that Bank of New York Mellon Corp , one of the world's largest custodial banks, has been overwhelmed by deposits and has begun charging some of its institutional customers a fee.
Another safe haven for corporations remains U.S. Treasuries, which emerged from the debt ceiling crisis as an appealing place to put funds even though Standard & Poor's decision to cut the United States' coveted triple-A credit rating on Friday night was widely expected.
In fact, the Treasury market rallied strongly over the past week with yields on the two-year note hitting a record low of 0.25 percent on August 4.
Supposedly savvy hedge fund managers also were quick to adopt a defensive stance this week. Many managers moved to liquidate stock positions to reduce losses at the first indications that this was going to be no ordinary stock pullback.
Some say a good deal of Thursday's 513 point drop in the Dow Jones industrial average was due to nervous hedge fund managers bringing down their exposure to U.S. stocks.
To that point, Options Clearing Corp says a a record 33.04 million stock options were traded on Thursday, an indication that many fast-money traders were using derivative contracts to hedge their exposure to stocks and other assets.
Trading was so frenzied on Thursday that it briefly led to a delay in processing some trades at Goldman Sachs Group's clearing business.
"Hedge funds have been reducing net exposure to the markets," said David King, a managing partner with Houston-based U.S. Capital Advisors, a financial services firm with about $1.5 billion in client money under management. "This to me looks a lot like what we saw last summer when the market pulled back and there was a radical change in sentiment."
In fact, others are pointing to similarities between this market swoon and one that took place last August. A Goldman Sachs trader issued a note on Friday in which he attributed some of the market turmoil to insurers buying Treasuries and selling equities. The Goldman trader said a similar thing happened last August when stocks fell precipitously.
Last year's summer sell-off only ended when Federal Reserve Chairman Ben Bernanke signaled the Fed was ready to provide more support to the U.S. economy, which eventually led to the central bank's purchase of $600 billion of Treasuries -- the second so-called quantitative easing, or QE2.
That bond buying came to end in June, and some analysts feared the rally in stocks would end once the Fed exited from the market.
One reason the U.S. stock market probably stabilized Friday, after falling sharply in the morning, was the news that the European Central Bank is willing to buy Italian and Spanish bonds if those governments make structural reforms. At least a few traders who did not want to be identified likened it to the ECB heading down its own quantitative easing path.
But it's not clear whether the Fed is willing to launch QE3 to give the U.S. economy another jolt. And it's also unclear whether politicians in Washington will be able to agree on any concrete plans for tackling the nation's 9.1 percent unemployment rate by providing the kind of stimulus that may be needed to get the economy back to any semblance of health.
The fear is that with the European debt crisis still unresolved and the U.S. economy limping along, investors may have to brace themselves for more scary trading days like Thursday. And it's not just in the equity markets that investors and traders need to prepare for the unexpected.
For example, John Taylor, who runs an $8-billion currency hedge fund in New York, says he was blindsided Thursday by the Bank of Japan's decision to intervene by selling yen to rein in the currency's gains against the U.S. dollar. Taylor, whose fund is betting on a strong yen, took a pounding on the move.
"We lost money yesterday," said Taylor. "We didn't have the right yen position. We didn't see this BOJ intervention coming. But we have mostly recovered our losses."
William Larkin, portfolio manager with Cabot Money Management in Boston, said months ago he told colleagues that if the yield on the 10-year Treasury dropped to 2.5 percent he would sell some bond assets -- but he never thought it would get there.
To his amazement it did and Larkin, whose firm manages more than $500 million, was able to do the trade and use the money to purchase some European assets and raise his cash levels.
"I had told them the alarm bell would ring if we breached 2.5 percent. I was joking because I never thought it would get that low again," Larkin said.
Then again, these are unusual times in the global economy.