A trader works on the floor of the New York Stock Exchange on Aug. 8, 2011. Photographer: Scott Eells/Bloomberg

Aug. 8 (Bloomberg) — U.S. stocks tumbled, dragging benchmark indexes to their biggest slump since December 2008, amid concern that a downgrade of the nation’s credit rating by Standard & Poor’s may worsen an economic slowdown.

All stocks in the S&P 500 Index retreated for the first time since at least 1996 as the index’s 10 main groups fell more than 5.3 percent. Bank of America Corp. tumbled 20 percent to lead financial shares in the S&P 500 down 10 percent, the most since April 2009. Ford Motor Co. and Caterpillar Inc. slumped at least 8.3 percent, pacing losses in stocks most-tied to the economy. Chevron Corp. dropped 7.5 percent as oil slid.

The S&P 500 retreated 6.7 percent to 1,119.46 at 4 p.m. in New York. The gauge slumped 11 percent in three days, the most since November 2008, and fell to the lowest since September. The Dow Jones Industrial Average declined 634.76 points, or 5.6 percent, to 10,809.85 today. About 18 billion shares changed hands on U.S. exchanges at 4:52 p.m. the fifth-highest volume since mid-2008, Bloomberg data show. Treasuries rose.

“There’s no reason to get in front of this train,” Keith Wirtz, Cincinnati-based chief investment officer at Fifth Third Asset Management, which oversees $16.7 billion, said in a telephone interview. “Yes, there’s cheapness in the stock market, but right now emotions are high. There’s enough uncertainty out there. People are moving towards no risk. That includes Treasuries, which is ironic.”

Bear Market

Global equities tumbled and European shares entered a bear market. The Stoxx Europe 600 Index has now fallen 21 percent from this year’s high on Feb. 17. The S&P 500 has dropped 18 percent since April 29. The Russell 2000 Index of small companies slumped 8.9 percent, entering a so-called bear market, down 25 percent from its April 29 high.

S&P lowered the U.S. long-term rating one level to AA+ after markets closed on Aug. 5, while keeping the outlook at “negative” as the company becomes less confident that Congress will end Bush-era tax cuts or tackle entitlements. S&P also said the U.S. rating may be reduced to AA within two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” result in higher general government debt.

Equities extended losses today as S&P also lowered credit ratings on Fannie Mae, Freddie Mac and other lenders with a “direct reliance on the U.S. government,” spurring concern over the ripple effects of the loss of America’s AAA rating. Stocks tumbled further after S&P changed the outlook for Warren Buffett’s Berkshire Hathaway Inc. to “negative” from “stable.”

No Liquidity Bust

The S&P 500 erased half its rally since the 2010 low of 1,022.58 in the first minutes of trading today then went on to wipe out 72 percent of the gain by the close, data compiled by Bloomberg show. More than 30 stocks fell for each that rose on U.S. exchanges, the broadest selloff since Bloomberg began tracking the data in 2004.

The worst stock decline since December 2008 is being absorbed by the market and while some investors panicked, there are no signs liquidity is being withdrawn as it was in the selloff of May 2010, traders said.

More than $860 billion of equity value was wiped out in 20 minutes on May 6, 2010, as market makers and other liquidity providers withdrew bids to purchase stocks, according to a report by the Securities and Exchange Commission and Commodity Futures Trading Commission on Sept. 30. The Dow fell almost 1,000 points before paring the decline.

No ‘Flash Crash’

“You can’t compare this to a flash crash,” Michael Shaoul, chairman of Marketfield Asset Management in New York, said in a telephone interview. His firm oversees $1 billion. “You’ve got an amazingly well-behaving system. It’s absorbing this pressure.”

Treasuries, benchmarks of the nation’s $34 trillion debt market that is more than twice the value of American equities, sent the 10-year note yield down 24 basis points to 2.32 percent, the lowest since January 2009, and the two-year rate reached a record low of 2.31 percent.

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co. increased holdings of Treasuries to 10 percent from 8 percent and cut cash holdings to 15 percent from 29 percent.

“If you’re an investor and you say, ‘I’m worried about what’s going on in the world, I’m worried about liquidity and safety,’ you basically have no place to go other than the Treasury market,” Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, said in a telephone interview. His firm oversees more than $38 billion.

‘Protect My Capital’

Barton Biggs, who last week called U.S. equities a “strong buy,” said he cut risk in his Traxis Partners LP hedge fund. “I’ve taken some risk off, and I hate to do it, I think it’s probably the wrong thing to be doing,” Biggs, who helps manage $1.4 billion as managing partner and co-founder of Traxis, said in a Bloomberg Television interview. “But I’m a fiduciary to a certain extent, and I’ve got to protect my capital.”

The Chicago Board Options Exchange Volatility Index, which measures the cost of using options as insurance against declines in the S&P 500, soared 50 percent, the most since February 2007, to 48. It was the highest level since March 2009.

The Morgan Stanley Cyclical Index of 30 stocks tumbled 9 percent. The Dow Jones Transportation Average, which is also a proxy for the economy, retreated 7 percent. Ford sank 8.4 percent to $9.93. Caterpillar decreased 9.2 percent to $82.60.

‘Double Dip’

The KBW Bank Index of 24 stocks slumped 11 percent. Bank of America dropped 20 percent, the most in the S&P 500, to $6.51. American International Group Inc. the bailed-out insurer, sued the largest U.S. lender by assets over $10 billion in losses on mortgage-bond investments.

“The bias that exists, and that is gaining credibility, is that a double dip is ahead of us,” said Charles Peabody, an analyst at Portales Partners LLC in New York. “If that’s the case, then something like Bank of America is going to have to raise substantial equity externally.”

Energy shares in the S&P 500 had the second-biggest decline within 10 groups, falling 8.3 percent. Chevron retreated 7.5 percent to $90.25. Exxon Mobil Corp. sank 6.2 percent to $70.19. Newmont Mining Corp. which rallied as much as 5.4 percent as gold rose to a record, slipped 0.5 percent to $54.13.

‘Minimal’ Effects

Berkshire Hathaway Class B shares slumped 6.5 percent to $66.65. Buffett lost his AAA rating from S&P last year after agreeing to buy railroad Burlington Northern Santa Fe. He said Aug. 6 that the ratings firm erred in cutting the U.S. grade and that the country should have a “quadruple A” rating. Buffett didn’t immediately respond to a request for comment.

The U.S. credit downgrade may spook investors, causing sentiment to grow bearish in the short term, before corporate fundamentals, including balance sheets with more cash than debt and earnings growth, will continue to push the S&P 500 higher by the end of the year, strategists at Barclays Plc, Citigroup Inc. and JPMorgan Chase & Co. said. While Goldman Sachs Group Inc. cut its year-end target for the S&P 500 to 1,400, Barclays held its 1,450 estimate.

“The medium to long-term effects of the U.S. sovereign downgrade are minimal, even as the short impact could be turbulent,” Thomas Lee, JPMorgan’s equity strategist in New York, wrote in an e-mailed note.

The benchmark gauge for American equities was still up 65 percent from a 12-year low on March 2009 following government stimulus measures and higher-than-estimated corporate earnings.

Earnings Performance

Per-share earnings increased 18 percent among the S&P 500 companies that have released quarterly results since July 11, according to data compiled by Bloomberg. About three-quarters of the companies have topped the average analyst profit forecast, the data show. Sales rose 13 percent during that period.

“We had a terrific earnings season,” Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said in a telephone interview. His firm manages $275 billion. “We’re not going into a recession. Now is not the time to panic. This is where you start to put cash back to work.”

To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net

To contact the editor responsible for this story: Michael P. Regan at mregan12@bloomberg.net