Is Main Street Abandoning Wall Street?

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George Marks

Call it the “fool me twice” market.

Skittish 401(k) investors aren’t sure about much regarding the stock market, but they do know this: Unlike 2008, when they were caught with their portfolio pants down, that’s not going to happen in 2011. Legions of Joe and Jane Doe investors are hurtling toward the exits — and that’s one of the single biggest factors that drove the Dow Jones Industrial Average down by 266 points (or 2.19%)  in Tuesday’s bloodbath.

Traders and analysts say the carnage was expected on a day when the S&P 500 turned negative for the year, given the lousy economic numbers on the manufacturing and consumer index out early this week. But the 401(k) issue may be the most surprising takeaway on one of the most memorable trading days in Wall Street history.

(MORE: The Unelected Winners and Losers of the Debt Deal)

Aon Hewitt, a Lincolnshire, Ill.-based human resources consulting firm, says that 401(k) trading account activity on Tuesday showed the third highest transfer amount out of equities since the firm began tracking such data in 1997. The firm tracks 4.7 million individual 401(k) accounts, and notes that a typical day’s trading volume lands in the $300 million to $400 million range. But Monday’s volume rose to $862 million and Tuesday’s to $900 million. Hewitt says that 95% of all 401(k) trading activity has been out of stocks and into bonds during the last week of trading.

On average, 401(k) investors lost about a third of their assets in the 2008-2009 market downturn. Clearly, investors don’t want that to happen again. “More fear and uncertainty had folks running to the sidelines rather than wanting to weather another one of those downturns,” said Pam Hess, Aon Hewitt’s director of retirement research, in comments to the Associated Press.

Regular investors don’t normally move markets, but this is different. Stung by losses absorbed in 2008, 401(k) investors, as the Aon numbers show, are paying close attention this time around. Tuesday’s lambasting represented the eighth straight day the DJIA was in negative territory. The stock market hasn’t seen that since the dark, dank and dismal days of October 2008, when Lehman Brothers bit the dust.

(MORE: The Faulty Logic Behind the Market Sell-Off)

What’s driving the uncertainty among 401(k) investors? Jobs and home values are part of it, of course, but this week it’s been all about the U.S. debt picture. Like a drunk dealing with a bad case of the morning-after shakes, investors showed little confidence in the debt ceiling deal that was struck in Washington earlier this week. Credit agencies weren’t thrilled, either. While Fitch Ratings came out with a statement supporting the deal and said the risk of default remains “extremely low,” it also issued a caveat: “The U.S. must also confront tough choices on tax and spending against a weak economic back drop if the budget deficit and government debt is to be cut to safer levels over the medium term.”

It’s also hard not to notice that the U.S.’s largest creditor is spitting nails over the debt debacle. China’s leading credit agency — Dagong Global Credit Rating Company — announced Tuesday that it was downgrading U.S. sovereign debt to single “A” status based on long-term debt repayment concerns. Dagon had previously downgraded U.S. debt in November 2010. If U.S. investors need yet another wake-up call, consider the dismissive tone by Dagong’s chairman Guan Jianzhong in explaining the downgrade with CNN on August 2:

“The squabbling between the two political parties on raising the U.S. debt ceiling reflected an irreversible trend on the United States’ declining ability to repay its debts. The two parties acted in a very irresponsible way and their actions greatly exposed the negative impact of the U.S. political system on its economic fundamentals. Our rating didn’t cause China to lose any money — it was the inappropriately high ratings for the U.S. by Western agencies that had led China to make risky investments in U.S. debt.”

China’s foreign exchange reserves total about $3.2 trillion – a big chunk of that in U.S. Treasuries. Toss in the lousy economic data we’ve already seen this week, and it’s no secret that 401(k) investors are looking at today’s market and are having Vietnam-like flashbacks to late 2008.

Given that, it’s not exactly a shocker that they’re exiting the market with as much cash as possible stuffed in their pockets.