Fearful investors exiting stocks and bonds alike

BOSTON (AP) ? This week’s debt-ceiling drama and disappointing economic news have sent investors heading to the exits, not just from stocks, but bonds as well. It’s true for virtually anything with a hint of risk.

All four categories of mutual funds and exchange-traded funds tracked by Lipper Inc. saw more money withdrawn than deposited over the seven-day period ended Wednesday. Such an across-the-board pullout hasn’t happened since last December, and the total amount withdrawn in the latest week was far larger.

Bond funds

Investors even pulled $1.3 billion from taxable bond funds, snapping a 32-week string of net deposits. Another $860 million exited funds that buy municipal bonds, normally seen as low-risk investments.

“That’s really the trigger that tells me everyone has been heading to the sidelines for now,” says Matthew Lemieux, a Lipper fund analyst. “There has been so much uncertainty that investors don’t really know where to go. So we’re seeing outflows, across all asset classes.”

Although the latest week’s retreat from bond funds was surprising, the amount pulled out was far smaller than for two other fund categories, stock funds and money-market funds. As the market tumbled, investors withdrew about $7.5 billion from stock funds. It was the biggest weekly outflow since last August.

Money-market funds

But the exit from stock funds was dwarfed by the nearly $66 billion in net withdrawals from money-market funds. They’re normally considered the safest thing next to cash and bank deposits.

As talks to lift the government’s debt ceiling stalled last week, the risk of a U.S. default sent investors fleeing money funds. Investors were scared off because nearly half of the $2.6 trillion that money funds hold is invested in Treasury bonds.

But with the debt ceiling deal signed into law Tuesday, and a default averted, money funds are starting to attract new cash again ? especially after this week’s stock market volatility.

The latest week’s flow out of money funds was the biggest since a record $144 billion was withdrawn during the week of the Lehman Brothers bankruptcy in in September 2008.

Volatility and flight to safety

Heightened anxiety can be seen in the stock market’s fear gauge, formally known as the Chicago Board of Options Exchange’s Volatility Index. The VIX, as market pros call it, has risen to levels not seen since May 2010, the last time stocks had a correction ? when a market index loses more than 10 percent off its recent highs.

At midday Friday, the VIX spiked to more than double its level of two weeks ago. On Thursday, when stocks tumbled 4.3 percent, the VIX jumped 35 percent.

“It tells us investors are panicking,” said Brian Reynolds, chief market strategist with WJB Capital Group, a Wall Street firm that handles trading for hedge funds and mutual funds.

In an unusually volatile market, investors trading on the VIX are willing to pay hefty premiums for options that offer protection from price swings of stocks in the Standard & Poor’s 500 index.

Reynolds expects stocks could begin to rebound a couple weeks from now, based on historic patterns following a surge in the VIX. But with so much fear in the market, stocks could still decline more next week, he says.

A further sign of the flight to safety: 2-year Treasury notes sank to a record low on Thursday, to 0.26 percent. On Friday, the yield rose slightly to 0.29 percent. Bond yields fall when demand for them increases.